Recent developments in Britain’s commercial property sector have highlighted the fact that South African listed property carries a higher risk than generally perceived, with the sector behaving more like equities than bonds in recent years. Listed property tends to track the performance of relatively stable long bonds in the long term because bonds and property are both income-generating investments. But in the short term, listed property in SA has been behaving like equities with some volatility.

Increasing interest and investment shown in the South African listed property sector by retail investors has resulted in greater volatility in unit prices. Previously, listed property was the preserve of institutional investors and pension funds, which appreciated the safety net of guaranteed income from the underlying property portfolios of listed property companies. Retail investors became more interested in listed property following stellar capital growth driven by excellent earnings over the past four years.

The Financial Times reported last week that the UK’s financial regulator had for the first time warned retail investors of the dangers of overexposure to property funds, just as small investors appeared to be accelerating their involvement in the sector. The newspaper said data released last week by the UK Investment Management Association showed that retail investors poured a record £1,1bn into open-ended property funds in the final quarter of last year, with 30% of all investment flooding into property in the final six months of the year. It reported the pattern was similar for close-ended funds, with more than a third of the £2,7bn raised by new issues last year going into property. This buying frenzy has led the Financial Services Authority to warn in its 2007 Financial Risk Outlook that there was concern that if there was a significant dip in the property market, retail investors could be affected adversely both by a drop in the value of their residential property and through any exposure to the commercial property sector in their fund portfolio.

UK-listed property securities, in which many retail funds invest, have risen 142% in three years. Although SA has not yet reached a stage where retail investors are overexposed to listed property, they featured prominently in the fallout in the sector last May, when it lost about 25% of its value after a listed property stock sell-off.

Evan Robins, head of fixed income at BoE Private Clients Investment Research, says the developments in the UK serve as a warning that listed property is risky. “While it’s a great investment for retail investors, they mustn’t put all their eggs in the property basket,” he says. “They should spread their risk and hold other low-risk assets such as cash and bonds,” says Robins. In the short term, listed property moved as sharply as equities. “It’s almost as volatile as equities, which means there is risk there. Listed property is not a very low risk investment in terms of capital,” Robins says. “You get income in the long term, but in the short term there is capital volatility.”

This volatility was apparent last year when the listed property sector lost 25% of its value. Although macro factors were in play — in that the listed property sector, along with other JSE sectors, was rocked by US interest rate hikes and emerging market jitters — retail investors were behind the sell-off of stock. “I think what actually happened was retail money was pulled from the sector all at once, which caused the fallout. It was pulled unjustifiably, and the prices have come back up,” says Robins. “If South Africans start to have the mania for property funds and put 40% of their wealth into listed property, on a risk management basis that is too high an allocation. “I wouldn’t put more than 25% of a balanced portfolio into listed property.”

Stanlib head of property funds Mariette Warner says retail investors need to ensure they get sound investment advice. “Always look to fundamentals, and avoid a strong momentum play,” she says. “In the South African commercial property market, the fundamentals are sound. However, the market is expensive relative to historical pricing. It is not a reason to panic.” Warner says that over the next three to four years investment in commercial property is expected to be sound as long as gross domestic product growth stays at about 4%. She also warns that listed property is a long-term investment. “Short-term investors do not belong in this sector because of volatility. You have to be there for the long term.”

Andre Stadler, MD of Catalyst Fund Managers, says that traditionally the listed property asset class’ total return has had a “relatively high income portion”. “Historically, in a low-growth environment, this income return has been above both cash and bonds. We now have entered a high-income growth phase with strong property market fundamentals. As a result, yields are much lower and the behaviour of the asset class is more like that of equities than bonds. “Given that most return expectations are driven by growth forecasts as opposed to income yields, the risk lies in a change in the view on growth, implying a potential for higher volatility.” Stadler says the reality now is that both cash and bonds offer higher-income yields than property. As a result an investor needs a longer-term investment horizon to reap the benefits of holding property as an asset class.

Colin Young, head of institutional property investments at Old Mutual Investment Group, says it is important to bear in mind that the UK is “at a low point” in terms of inflation, as well as yields. “Therefore, given that property yields are trading below bond yields, I’m not surprised at this warning.” He says the concern in SA is that low bond yields are trading at 8% while forward yields on well-rated listed property stock is edging over 7%. “They are well below bonds. This means that a risk of correction in prices increases. I would expect the same similar cautiousness from South African property analysts because we find ourselves in a similar position to the UK where property yields are below bond yields.”