Investment 2002. FM 4 Jan 2002
By Ian Fife
Like Goldilocks, property investors want a dish that's not too hot and not too cold but just right
The property industry is on the cusp of change - and the good news for investors is that the change won't be too dramatic. If there's one thing that investment property thrives on, and helps create, it is stability.
Experts foresee a decade of single-digit inflation, steady interest rates and regular growth in rents and values. 'We are returning to a macro-economic environment not seen in SA since the Sixties,' says property economist Francois Viruly. 'The shift to low inflation has been painful but international experience shows that a stable, low inflation era creates a good basis for property investments.'
Despite the volatility of the rand and a possible increase in interest rates, homeowners and landlords should look beyond the shaky start to 2002, say the experts.
Viruly, who is banking on steadiness, says such an environment will bring out the best in SA property. The consistent, annuity-type rental incomes that property generates will make it as attractive as gilts. Growing confidence will lead to more investors and growing real values.
This will give property the attraction of equities, reviving the sector's fortunes as one of the three main asset classes with a place in most balanced investment portfolios.
If the experts are right, SA property to 2010 will emulate US and European real estate in the Nineties. In America they called it the Goldilocks era - not too hot (boom), not too cold (bust), but just right - and it brought great wealth to property owners. Real house prices in London have risen 850% since 1981 and the number of listed property funds on the New York Stock Exchange has risen to 279.
SA, with its volatile past , has not fared nearly as well. Over the same period, real SA house prices dropped by 15% as high inflation, boom-and-bust interest rates, and political and civil mayhem took their toll. 'Investors anxious about rising interest rates should note that volatility, rather than the actual rates, is what hurts property most,' says Viruly.
There are clear signs of a change for the better. For one thing, the slide in institutional property investment from 20% of total investment a decade ago to a little over 5% has stopped, says Royden du Plooy, director of Cape property conglomerate Catalyst. Institutions, with about R70bn in holdings, make up the largest property subsector outside government.
Another sign is that SA is rapidly joining the worldwide trend to securitise property, mainly by listing on the JSE. There has been marked growth in property unit trusts (PUTs) and property loan stock companies (PLSs).
The market capitalisation of PUTs and PLSs has grown from R5,4bn in January 1999 to R13,5bn today, mainly from the conversion of institutional property into funds. Promoters are bringing new funds to market this year that could total R10bn. Add the R23bn of Liberty International and other companies in the straight property subsector, and the real estate sector on the JSE could reach R50bn by year-end.
A third sign is the increased share in property investment by entrepreneurs and private funds. Ironically, though, this may adversely affect the very stability that property investors crave.
Unlike institutions, private investors gear their properties, using their value as security to borrow between 50% and 80% of the purchase price. This means that interest rates are no longer merely an opportunity cost, but a reality, says Viruly .
'When a building needs a tenant, the geared owner must fill it or sell it at the going yield. This creates more fluidity in the market and the sector responds directly to the macro-economic environment. It also means that properties that make up the new funds will be worked more thoroughly than before ,' he says.
Already, 'smart' income funds such as Redefine, Primegro and Apexhi have come to market. They have special financial structuring to enhance their yields and are run by property experts rather than institutional fund managers.
The growing confidence in property is not surprising. It has outperformed other JSE sectors over one, three and five years. If you had invested R100 000 in a basket of 25% each of Hyprop, Martprop, Grayprop and Sycom on January 4 1999, you would have had a total return of about 100% in three years and a current value of R177 000.
As good as that is, property has another purpose as an asset class, says Corovest Property Group director Mike Aitken: 'As the conservative part of a balanced portfolio (equities, cash, offshore, and so on), it provides steady income and growth that is not influenced by short-term events.'
Unstable equity markets have highlighted the 'safe haven' role of property. PUTs and PLSs held their own as other sectors plunged. But Du Plooy, Viruly and Aitken say yields fell (and therefore values rose) too far. 'There has been a tendency to value funds by market cap rather than the quality of the underlying property,' says Du Plooy.
Aitken feels the recent rise of yields to 13%-14% with the sudden fall of the rand and jump of long bonds from 9,3% to over 12% was timely: 'The sector was moving ahead of fundamentals.' But he notes it was private investors who ran for cash while the institutions hung on to their property shares. 'Average yields in the PUT and PLS sectors of about 1,5% above the RSA 153 are healthy,' says Aitken.
Fund managers worldwide benchmark their property yields against treasury bonds. At that margin the sectors will attract institutions looking for hedging instruments to balance their gilt and equity cycles, says Du Plooy.
But investment in property will not be uniformly golden for a few years. For instance, there is a huge oversupply of office space . Large shopping centres have also run ahead of retailer demand. The resulting poor performance of some funds will trigger a more critical approach to the sector from investors this year. Merrill Lynch has already downgraded the projected payout of the biggest PUT, Grayprop. Experts differ on where the investment will go as a result. Aitken and Du Plooy see a flight to quality, mainly the larger funds .
But Corpcapital's property dealmaker, Marc Wainer (Hyprop, Redefine and Apexhi), and PLS Spearhead CEO Mike Flax say size will no longer drive value. 'Investors will start looking at the actual properties in the funds and the performance of their managers rather than size,' says Wainer.
The hottest property investment right now is in residential property. All the commercial property managers agree this offers the greatest opportunity in the short term. This sector never had the institutional support enjoyed by commercial property in the past 25 years and was far more damaged by SA's political and economic woes. As a result, even using a purchasing power parity exchange rate of about R6/US, SA house prices have fallen to among the lowest in the world.
Though nominal prices have risen more than 75% in five years, growing household incomes and falling interest rates still make buying a home more affordable than at almost any time in the past 15 years.
Residential rents have risen almost 12%/year since 1993, so investors who bought flats in prime areas five years ago, probably at initial yields of 10%, would have had total returns of around 25%/year, says Neville Schaefer, CEO of residential managers Trafalgar. A R200 000 two-bedroomed flat would now be worth about R400 000 and the rent would have doubled to about R4 000/month.
Unlike commercial rents, which are more closely tied to GDP and other broad economic indicators, residential rents are driven by household disposable incomes. 'Residential rents have risen without fail every year since 1980,' says Schaefer.
Absa projects that real household disposable income per capita will rise by about 2,5%/year over 10 years. In a Goldilocks environment, a residential investor can expect his or her nominal rents and values to grow around 7,5% each year, giving a total annual return of about 15% and a real return of 9% each year for 10 years.
Pam Golding Gauteng head Ronald Ennik says the residential market has already gained from the instability of the JSE in the past 18 months. But continual price rises of more than 15%/year in the past three years and the Zimbabwe land invasions have left buyers at the high end jittery. The rand's fall and the threat of high interest rates is not helping, either. Absa still projects nominal price growth this year of around 10% after 18% last year. But it takes only 15%/year for five years to double values.
The low-cost housing market is likely to miss out on this wealth-creating opportunity, however. Penny Brothers valuer Conrad Penny estimates 1m low-income householders have bought homes since 1991. Average nominal affordable house prices might have risen, but the average household has lost half its investment value in the property in real terms after allowing for inflation.
This market has two serious problems: there are few estate agents and the banks have stopped giving mortgage bonds, so there is no secondary market. Banks are working on new financing structures that will allow them to lend without ending up with billions in write-offs. But their contribution so far is insignificant. The opportunity to build wealth is being lost.
There is some gloom even at the top end of the market. Mike Crawford, chairman of RPP Developments fears high inflation and interest rates over the next decade. This could be worsened by government delivery of welfare and public works services pushing up inflation, he says. The oversupply of offices and shops means there will be little work for developers.
But most others are bullish. Corovest's Aitken says: 'We might have a tough two years, but the steadiness of a Goldilocks economy will mean steady real growth, even at higher rates.' 'I think our macro-economy could prove to be among the best-managed in the world ,' says Du Plooy. 'Barring political surprises, we are headed for an ideal environment for property investment.'
Publisher: Financial Mail
Source: Ian Fife
Like Goldilocks, property investors want a dish that's not too hot and not too cold but just right
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