By Stafford Thomas 

Most experts feel strongly positive, as long as rates don't rise       
  
Seven years ago property income yields were at record highs, yet few investors would touch property. SA's only property fund at the time, Marriott Property Equity, had assets of R40m and, at the market's weakest point in October 1998, offered a yield of 25%. 

By the end of 2004 the fund had delivered a total return of 320%, driven mainly by falling interest rates and a rerating of property stocks. The sector now has 11 members, only four with a three-year track record, and total assets of R6bn. 

Assets would be far higher if it were not for a lack of suitable property loan stocks (PLSs) and property unit trusts (PUTs) to invest in. "It's hard to get good lines of stock," says Stanlib property fund manager Mariette Warner. 

Already four funds have closed their doors to new investment. More are likely to follow.

The sector has all the attributes of a bull run at an advanced stage, yet most market participants are far from cautious on prospects.  "We are very positive," says Colin Young, manager of Old Mutual SA Quoted Property Fund, 2004's sector leader, with a 38,5% return.

"Old Mutual Asset Management expects a stable rand and a structural move to lower inflation over the next three years. There may be some bumps on the way but nominal interest rates will come down."  Warner holds a similar view: "The interest rate environment is stable and the physical property market is a lot stronger; the risks are low," she says. 

Amid the optimism there is a voice of caution . Says Marriott property fund manager Ian Anderson: "All the good news is already priced in to the sector. This is seen in the abnormally high 20% average premium that PLSs and PUTs are trading at relative to their NAV [net asset value]. From here on, performance will depend on growth in distributions and interest rate moves." 

If interest rates remain stable, this will mean capital growth of about 5%/year based on expected increases in rentals. The premium to NAV is not seen as a threat. Reflecting the general view, Mike Flax, CEO of PLS Spearhead, says: "Capitalisation rates [the return demanded by property developers and buyers] are falling. This will boost property values and will see NAV catch up to prices." 

Anderson says he thinks it will take far longer than a year to close this gap. 

Ultimately, he stresses, "Property investors are now taking a bet on rate movements, which in turn are heavily influenced by the rand's movements. If rates stay stable, the market will not fall out of bed. But if rates were to start rising, I don't want to think what could happen to property valuations." 

And with the average 8,3% average yield on top-quality PUTs providing a minuscule 0,2 percentage point "risk premium" over the R153 benchmark bond's yield, it seems there's not much room for error.