Property market due for a slowdown after five-year run

Investments in property provided dramatic returns in recent years, but there are signs that things are changing. At least one fund believes cash will be a better investment over the next three years.
April 21, 2007

By Neesa Moodley

While the property market has flourished in the past five years, providing investors with an average rate of return of 31.86 percent a year over this period, the outlook going forward does not appear to be so rosy.

Fund managers in the market believe the average 32 percent rate of return in the listed property market is unlikely to be matched over the next five years, since the sector seems to be fully priced at the moment.

The property market has yielded a high average rate of return of 19.67 percent in the past year and 39.69 percent over the past three years.

The Coronation Property Equity Fund turned in a good performance as the top performer over the past five years with an average return of 33.49 percent.

High valuations

Edwin Schultz, the fund manager of the Coronation Property Equity Fund, says the market ran quite hard, with valuations becoming full or overpriced. The fund's mandate allows it to go to a 50 percent cash holding or non-domestic listed property.

"We have done that to some extent. The fund at the moment is invested 82 percent in domestic listed property, five percent in Liberty International and 13 percent in cash. We believe that one should invest in international listed property," he says.

Looking at the next three years, Schultz believes property in general will underperform cash, although some property companies with increased rental income will be able to outperform cash, providing the possibility of capital gain. Companies with potential for increased rental incomes are those with portfolios that include large regional shopping centres and office parks.

While other property companies are showing similar growth levels, their portfolios are not as promising in the long term, with less likelihood of distribution growth exceeding inflation over the longer term.

According to Schultz, the local listed property market tends to be homogeneous, with all listed properties negatively or positively affected by the same factors, such as currency movements or inflation.

"Our general strategy over the past five years has been to diversify. We have gone as high as 20 to 25 percent on cash holdings as property has outrun fundamentals but not quite to 50 percent although the fund mandate allows it," he says.

Schultz says the bias will be towards retail in the long term, as opposed to exposure to office and industrial property, since there is better distribution growth in retail properties over the longer term and companies with such exposure are more defensive investments when the market takes a downward turn.

"Right now, rental growth rates are high and driving good returns, but we don't think these growth rates are sustainable in the long term. The cycle for office properties, however, does look more promising over the next three years," he says.

Top performer

The Oasis Property Equity Fund was the top performer on PlexCrowns ratings for periods up to five years to the end of March this year, achieving the highest rating of 5.000 PlexCrowns.

Fund manager Michael Swingler says Oasis is fully invested in property unit trusts and property loan stocks and property-related companies.

The fund has less than five percent in cash holdings, primarily to provide liquidity. Swingler attributes the fund's performance to its diverse portfolio with different property companies, which "helps at times when the market is more volatile".

Oasis anticipates further volatility in the property market.

"On an income yield basis, the listed property sector is fully priced and you will not see substantial returns from further rerating of yields, but there could still be substantial growth in terms of income growth driven by the strong fundamentals supporting rental returns growth," Swingler says.

He says the average 31.86 percent rate of return from listed property in the past five years is unlikely to be matched in the next five years.

"Yields came down from the 10 percent level to current levels of between six percent and seven percent, which resulted in substantial capital profits for investors. We don't think that's likely to recur," he says.

Bond yields

According to the Market Dynamics newsletter of the Old Mutual Investment Group South Africa (Omigsa), the greatest risk to the property sector is a sustained rise in bond yields to higher levels.

This risk would be intensified if domestic interest rates rose, but over-reactions could provide you with an opportunity to buy property.

Omigsa believes the listed property sector is fairly valued relative to bonds at the moment but it does offer attractive risk-adjusted returns over the long term.

Patient investors in listed property will benefit from sustainable growth in distributions over the next few years, which will translate into capital over time, says Omigsa.
(Persfin, April 21, 2007)

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