Listed property likely to deliver modest returns

09 November 2017

The listed property sector has delivered exceptional returns over recent times. In fact, over the 15 years to September 2017 the sector gained 22.2% per annum, well exceeding equity returns of 15.9% a year. Hence our tactical underweight to neutral stance.

This is a return most investors especially notorious for being “eternal property bulls” have grown accustomed to. The sector’s contribution to general equity benchmarks has also grown significantly from a meagre 2% to just under 7% during this time. This is not only owing to the performance of the sector but also ongoing capital raises — about R80 billion has been raised by South African property players in just under two years. Its allocation within multi-asset portfolios including retirement funds has also gained traction.

 The largest drivers of return have been capital or share price appreciation emanating from two sources: compressed yields and dividend growth. First, listed property yields have declined from levels of 13% (seen 15 years ago) to about 6.8% currently. This compression coincided with similar moves in global bond yields and other income yielding assets because of quantitative easing, or asset purchases, by major central banks aiming to revive and stimulate global economic activity following the global financial crisis. Major central bank balance sheets have swollen to about $14 trillion as they have bought both corporate and sovereign bonds, pushing developed market real rates to all-time lows and into negative territory. Low bond yields in turn drove other financial asset prices and valuations to elevated levels even in the absence of earnings growth to justify such valuations and lack of inflation. There is, however, less commitment to quantitative easing and a mulling of potential unwind of these balance sheets, which will reduce liquidity and support low for bond yields

This reduced liquidity could lead to a gradual increase in listed property yields and remove support for share prices.

The largest drivers of return have been capital or share price appreciation emanating from two sources: compressed yields and dividend growth. 

Secondly, in the absence of gearing, accretive acquisition pipelines and financial engineering, dividend growth is simply driven by macroeconomic conditions as well as property demand and supply fundamentals — which determine whether net rentals increase or decline. South Africa makes up about 60% exposure within the South African listed property benchmark. Given the benign economic outlook and weak property fundamentals, growth from locally sourced income is likely to continue to come under pressure. We are expecting economic growth of just 0.7% in 2017 and an improvement to about 1.2% in 2018, which is clearly lackluster and unlikely to lead to any meaningful support for overall rental growth. Likewise, recent IPD/ MSCI data has shown rental growth slowing in the second quarter of 2017. The retail sector which makes up the greatest proportion of local property exposure, and the best performing sector until recently, is also showing signs of weakness. Pressure on trading densities in shopping centers and a slight uptick in vacancies following the demise of the likes of Platinum Group (Aca Joe, Hilton Weiner, Urban), Stuttafords, and some standalone mono-branded small format shops like Mango is quite evident. Not all the space made available will be absorbed even by recent international entrants into the local market who have expansion ambitions. The rest of the income within the benchmark originates offshore, most of it from Central Eastern Europe (about 22%) with less exposure from developed markets. Given the lack of attractive opportunities locally, economic challenges, as well as lower funding costs relative to development and acquisition yields, numerous funds have been increasingly re-allocating capital to these territories. Of the R80 billion capital raised these two years, the majority thereof was or will be deployed offshore. This could underpin dividend growth and potentially provide a surprise on the upside. If you exclude the offshore income, the sector’s distribution growth would be just over 6%.

Given the above scenarios, Ashburton Investments’ multi-asset funds retain a slightly underweight to neutral exposure to this asset class ranging from about 5% to 9% depending on the mandate and return targeted. It is also important to note that our expected returns from various asset classes have also converged.