LPTs pause to gather next wind
IS this the end of the bull run for listed property trusts? The flat, indeed negative, performance over the past six months has caused many commentators to question if their extraordinary run of earlier days can be sustained.
In the three years to the end of 2006, LPTs averaged annual returns of more than 25 per cent, and turned in 16 per cent over the previous decade.
The argument goes that LPTs have had their run, that they have pulled ahead of property values, that yields are too low, that property trust operations have been mixed up with other businesses such as development and are no longer pure, that LPT yields below bond rates don’t make sense because of the relative security of bond assets, that super funds should re- weight towards other asset classes, that LPT prices have peaked and that LPTs will lag over the next few years.
Rubbish. That’s all equity analyst speak and doesn’t make sense to me.
Shares ain’t just shares. I like to look at the assets underpinning a share to understand how it will perform. BHP isn’t just a share — it’s an operating company. Sure, it can fall in and out of favour, thereby affecting the share price in the short term. But mediumterm share performance will be driven by the company’s operations.
LPTs operate in property markets. And those property markets happen to be of particular interest to me.
Property markets will be strong over the next few years, not weak. I’m a patient investor and, for me, any weakening in share prices due to market sentiment rather than market realities present an opportunity.
Let’s work through some of negative arguments.
On the yields argument, my response is that property is a real asset.
Returns on property do not include just the yield. The larger part of the extraordinary returns experienced in the last decade have been associated
the with capital growth ( rather than rental income). In fact, it is that firming of property yields which is now causing concern about the relationship with bond yields.
real- value asset with the nominal returns locked in at the beginning.
When bond yields rise, bond prices fall.
Actually, worldwide bond rates are still low — that is what’s driven the private equity boom as well as the strength of investment markets around the world. They have recently started to rise and could rise a lot further.
There is nothing to say that property yields should be higher than bond yields.
It’s nice when they are. That’s what drove an earlier surge of investment into property, using security of cash flows to gear up property investments that ‘‘ washed their faces’’ with yields above interest costs.
The private equity logic went through property markets long before we saw it in equity markets, largely because cash flow for some kinds of property were more secure than for companies, though strongly rising and consistent profit results for companies over several years have now boosted confidence ( and the assessment of risk) to allow more confident gearing.
But when yields fell below interest costs, the surge into property continued, with no shortage of arrangers taking a fee on the way in and a fee on the way through and relying on income and capital growth to boost returns.
Even the concerns with security of income to service debt started to soften as investors recognised the strength of leasing markets.
To me, in the current environment bonds are a more risky investment than property.
On the point that LPTs include property assets stapled to property operations such as funds management, development or construction, my response is that this is nothing new.
The strong performance of the last few years has included these sorts of stapled activities. The question is how they will perform over the next few years.
The point is that we are just entering a strong phase for property markets that will underpin LPT returns.
Total returns will be dominated by capital growth and augmented by yield.
Retail property will be underpinned by strong retail sales. Industrial property is benefiting from a strong phase of investment in the economy. The shortage of hotel rooms means that the hotel market is about to experience a substantial boost to revenues and prices. And commercial office property is on the threshold of a major construc- tion phase as strong demand is being confronted with a shortage of supply, leading to rising rents, firming yields and rising prices.
We forecast solid to strong internal rates of return in most non- residential property markets over the next few years.
That should be reflected in income growth and revaluations, underpinning healthy returns to the property investment components of LPTs.
And sure there are other operations stapled to property. But those operations will also be experiencing strong, in some cases boom, conditions and should on average do extremely well.
To look at the last six months of weaker performance as a precursor to future returns doesn’t make sense. To me, this is just a pause gathering the strength to underpin the next upward movement.
There will be a time to sell. But this isn’t it.