Listed property still leading the pack

Posted On Friday, 22 July 2011 02:00 Published by eProp Commercial Property News
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Property stocks could pip general equities at the post again this year, while the listed property index hit a new record high earlier this month after dipping 10% in the first quarter.

Angelique de RauvilleListed property was the more profitable bet in 2010, with a total return of 30%, well ahead of the Alsi’s 19%. Though neither asset class is expected to match that level of return in 2011, for the year to date investors are still making more money on real estate than on general equities.

Property stocks have delivered a total return of 2,76% in first-half 2011 compared to the Alsi’s 0,5%, figures from Catalyst Fund Managers show. But the total return difference between the winning and losing property stocks for first-half 2011 is a substantial 49% — Fortress B with a high of 23% and Hospitality B with a low of -26%.

Fortress B, the Resilient group’s speculative hybrid play, continues to test new highs. The counter’s split-unit and gearing structure means that the company can produce above-sector income growth during the good times. B units’ downside can be equally pronounced when the going gets tough, as has clearly been illustrated by hotel fund Hospitality. The company’s B units have taken a hammering over the past two years from falling hotel occupancies and revenues.

Catalyst investment manager Paul Duncan says a key reason for the listed property sector’s resilience is its fairly predictable and growing income stream. Listed property portfolios are still delivering inflation-beating income growth of an average 6%- 7%. That’s because tenants who occupy the retail, industrial and office buildings owned by listed property funds are locked into annual rental escalations built into lease agreements.

However, Duncan expects the performance gap among the 21 counters that comprise the R133bn listed property sector to narrow over the next six to 12 months. “Most stocks are now looking fully priced, with little differential in their relative value. So it’s becoming more difficult to pick the counters that are likely to outperform over the shorter term.”

He is keeping a close watch on Hospitality B, which he believes has been oversold. “Too much bad news has been priced into the B units. We won’t buy yet, but if and when hotel occupancies start to recover, the counter offers recovery upside.”

Risk-averse investors looking for more predictable returns should include Fortress A in their property portfolios. Duncan says one can now buy the counter at an attractive forward yield of more than 9%, with income growth of 5%/year virtually guaranteed.

Despite some short-term share price weakness, he expects the listed property sector as a whole to deliver an average 13%-14%/year total return over the next five years.

The risk to total returns in the short term is a weakening in capital markets, he says. But even if share prices stay where they are over the next 12 months, listed property investors will still earn an average income return of around 8,5%, which Duncan says compares favourably to cash and bonds. The SA benchmark overnight deposit rate is now at 5,29% while the long-term government bond index yield to maturity is at 8,37%.

Investec Asset Management portfolio manager Angelique de Rauville expects a total return of 12%-14% for 2011 as a whole, and says a similar level of returns is achievable over the next three to five years. She says there have been only two years since 2000 in which the sector has returned less than 15%.

De Rauville favours counters that are likely to deliver above-sector income growth, including Capital Property Fund and sector heavyweight Growthpoint Properties. “Capital’s merger with Pangbourne will unlock value as duplicate expenses are reduced out of the system. The sell-off of nonperforming assets will also help improve the quality of Capital’s income streams.”

De Rauville says Growthpoint’s distribution growth performance will be supported by a strong contribution from its Australian property interests through Growthpoint Australia.

However, she cautions that rising operating expenses are a concern for the listed property sector, as they make it more difficult to grow rentals when leases come up for renewal. The cost-to- income ratios of listed property companies, driven by sharp electricity tariff increases as well as higher municipal rates and taxes, have already risen noticeably. For instance, blue chips like Hyprop Investments and Resilient Property Income Fund have seen their cost- to-income ratios rise from 31,15% to 37,76% and from 30,03% to 32,12% respectively over the past two years.

Listed property companies have in the past negated the effect of rising administered costs by raising rentals. But De Rauville says landlords’ ability to do this has been diminished, not only because the sector is coming off a relatively high vacancy rate but because tenants are struggling with an expanding cost base.

And lower — or no — rental increases amid rising operating costs could eventually translate into lower growth in income payouts.

Last modified on Friday, 25 April 2014 17:33

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