Neil Stuart-Findlay, portfolio manager of the Investec Property Equity Fund, shares his prospects for the listed property sector
- Despite fluctuations in share prices, the sector continues to offer investors a predictable and growing income stream
- Recent price volatility in the SA Listed Property sector was a result of rising global bond yields, putting pressure on SA bond and property yields
- Property fundamentals in South Africa remain solid and distribution growth is forecast to accelerate in 2013
- Income and distribution growth will be the primary drivers of return, not continued re-rating
- Careful stock selection will become an important return differentiator in the current market environment as relative valuation dispersions increased
- The quality and sustainability of distribution growth are key drivers in our high-conviction portfolio during the current uncertain times
- Listed property is an important diversifier of an investor’s portfolio
Volatile prices despite stable fundamentals
The listed property market has experienced some volatility over the last two months. Following strong gains of 35% in 2012, the SA Listed Property Index had an exceptional start to the new year. However, in May the sector declined 11.1%, which was followed by a gain of 4.4% in June. Despite this volatility, the listed property sector was still up 8.8% for the first half of 2013, well ahead of domestic equities and cash, which gained 2.3% and 2.6% respectively.
This volatility was primarily as a result of a change in US central bank policy and not due to a change in the fundamentals of the domestic listed property market. Indications from the US Federal Reserve that they may start gradually reducing the level of monetary stimulus have shifted expectations of investors across the world and had a direct impact on domestic investment markets. Less liquidity, a reduction in quantitative easing and indications that short-term US interest rates could possibly start rising in the next year resulted in US bond yields rising. This rise put pressure on bonds across emerging markets and in SA. This in turn negatively impacted the share price performance of SA listed property stocks as valuations of this sector are directly driven by the level of bond yields.
Returns to be driven by income (yield) and income growth
Over the long term the listed property has generated steady returns from an income and a distribution growth perspective. The ability of the sector to grow income over time is one of the primary contributors to generating higher real returns for investors. This attribute differentiates listed property from asset classes such as cash and bonds, where income is primarily fixed.
In the first half of this year, the sector generated an income return of 3.1%, whilst returns from distribution growth counted for a further 4%. However, the strong gains last year from a re-rating perspective on the back of lower bond yields have abated. Following the recent correction, prices have normalised to levels seen at the beginning of the year, highlighting that the yield compression seen in the first four months of the year was overdone. In our view, current valuations are at a level which is more conducive to the generation of sustainable returns going forward.
We believe it is unrealistic to expect the SA listed property sector to repeat the exceptional returns from last year, as it is unlikely that the sector can continue to re-rate (yields moving even lower). However, returns between 10% and 12% can be achieved from current levels considering a healthy yield and solid distribution growth. Calculated from a bottom-up perspective, distribution growth for the sector is expected to accelerate to levels above the long-term average, growing at c.7.5% in 2013 followed by c.7.8% in 2014.
It is important to note the high level of stability in the distribution growth over time, especially when compared to the fluctuations in earnings from other equity market sectors. Stable, contractual lease escalations which underpin top-line growth have been the primary driver of the high degree of earnings certainty over time. Importantly, these lease escalations continue to run at approximately 8%. This is well ahead of inflation and forms the foundation for our forecast for real distribution growth over the next two years.
While it is important to note that the underlying fundamentals of the listed property sector remain solid, the recent price volatility highlights the sector’s sensitivity to yield movements in the domestic bond market. Continued pressure on domestic bonds poses the highest risk to short-term price movements in the sector.
Careful stock selection to become an important differentiator in the market
Careful stock selection is becoming increasingly important. Against a backdrop of macroeconomic uncertainty, we place emphasis on carefully selecting stocks with:
- a quality earnings profile which is resilient during times of uncertainty;
- an experienced management team backed by a strong track record; and
- an attractive absolute and relative valuation.
One of our largest overweight positions is Hyprop Investments, a blue-chip growth investment which offers our investors exposure to a portfolio of South Africa’s premier listed regional and super-regional shopping centres. These include the likes of Canal Walk, Clearwater Mall, Hyde Park and The Glen.
This segment of the real estate market has proven to be the most defensive through the economic cycle, a crucial advantage in the current challenging economic environment. Hyprop’s assets are underpinned by a high proportion of national and international retailers, which are backed by strong balance sheets. The company has an exceptional long-term track record of management delivery, where distribution growth has consistently exceeded the sector over time and results have met or beaten market expectations.
Looking forward, Hyprop has an accelerating growth profile over the medium term, which will be bolstered by the completion of Rosebank Mall in the first half of 2014.
We remain positive on the sector
Recent volatility in the listed property market was driven by events impacting the domestic and developed bond markets and not as a result of any change in the underlying fundamentals of the sector.
- The sector, driven by contractual lease escalations, offers a healthy and growing income stream.
- Despite short-term volatility around share prices, investors can rely, with a high degree of certainty, upon growth in their income, which over time is one of the primary contributors to generating real total returns.
- Growth in income differentiates listed property from other fixed income asset classes such as cash and bonds where income is fixed and currently provides little or no protection against inflation.
- Listed property is a key component of any well-diversified portfolio and has the ability to enhance real returns over time at less volatility than equities.
Source: Neil Stuart-Findlay, portfolio manager of the Investec Property Equity Fund. For more information, see www.investecassetmanagement.