Investors in South African real estate general funds have enjoyed spectacular returns over the five years to the end of September, but returns for the past quarter turned negative.
The FTSE/JSE Listed Property Index returned 20.57 percent a year over the five-year period (according to ProfileData), beating the FTSE/JSE All Share Index’s return of 16.38 percent for the same period.
Over the five-year period, the average return of funds listed in the South African real estate general sub-category was 17.68 percent a year, as opposed to an average annual return of 14.46 percent for South African equity general funds.
For the one-year period to the end of September, real estate funds earned 10.6 percent on average, which was very much in line with the return of the FTSE/JSE Listed Property Index for the year (10.28 percent).
However, in the quarter to the end of September, the index retreated 1.31 percent and real estate funds were the only sub-category to produce a negative average return (minus 0.04 percent) over the period.
The South African Real Estate Investment Trust Association (SA Reit) says the high volatility of South Africa’s listed property sector over the past year has largely been blamed on rising bond yields, which, conventional wisdom says, are bad for property returns.
But the association says that more and more research shows there is little empirical support for this thinking, and, in some cases, bond yields can rise and property returns can improve at the same time.
It is important for investors to realise that there are many different outcomes for property returns, even as bond yields rise, SA Reit marketing committee chairman and the chief executive officer of the Vukile Property Fund, Laurence Rapp, says.
Rising bond yields are just one of a host of factors that affect property returns, he says.
Recent research by Towers Watson, a company based in the United Kingdom that specialises in risk and capital management, found that little evidence exists to support the view that rising bond yields mean declining property returns. Similar research undertaken in the United States reached the same conclusion.
In fact, the US research suggests that property investments perform better when interest rates are increasing, particularly during periods of economic growth when property fundamentals are strong.
“Although research on this topic is limited, it underscores the need for investors and analysts always to assess a range of factors when considering property investments, listed or direct,” Rapp says.
The South African listed property sector has out-performed all local asset classes for 11 of the past 13 years, with lower volatility in returns than general equities, he says.
Investors should consider returns from listed property through an investment cycle (a longer period that includes bull and bear phases) and not be too focused on short-term volatility, he says.
“The defensive nature of property as an asset class is evident in its long-term out-performance of equities and bonds,” Rapp says.
If higher inflation pushes up bond yields, property portfolios with inflation-linked leases could, in fact, benefit, and higher inflation is often driven by a buoyant economic environment that is positive for commercial property, he says.
“In South Africa, where property leases are typically signed with built-in net rental and operating cost escalations, this is a feasible scenario,” Rapp says.
Ian Anderson, chief investment officer at Grindrod Asset Manager, says that, when valuing listed property, South African investors typically focus only on the current yield of listed property relative to bonds and ignore the potential for listed property to grow its income. Or, they apply a very low long-term growth rate to their income forecasts, he says.
In its multi-asset funds, Grindrod has an allocation of 25 percent to listed property and no exposure to bonds, Anderson says.
Despite SA Reit and Anderson’s bullish views on property, many managers are cautious about their exposure to listed property.
Prudential Portfolio Managers, for example, is slightly underweight on listed property on all of its multi-asset class funds, Hamilton van Breda, head of retail sales at Prudential, says. This is because property yields are still out of line with bond yields, having sold off less than bonds so far this year and making property more expensive in relative terms, he says.
Listed property valuations are also expensive relative to their historical levels, he says.
Prudential is of the view that the fundamentals in the secondary-grade office market are weak, although the fundamentals in the dominant regional shopping mall and warehousing markets are good, Van Breda says.
Prudential believes that, compared with cash, listed property offers better prospects, he says.