Property can play an important part in an attractive portfolio

• Market has historically outperformed equity dividends and the trend is expected to continue

Property is one of the oldest investment alternatives. While its attractions are obvious — it produces a fairly consistent income stream linked to inflation and enjoys equity-like characteristics — it has only become a mainstream asset class in South African investment portfolios in the past 15 years.

Seen as part of listed equity, property made up less than 1% of the market in 2002, partly due to its illiquidity, small capitalisation and a shortage of listed vehicles. Listed property accounts for nearly 7% of the FTSE/JSE Shareholder Weighted index nowadays, with more than 55 companies to choose from and a total market capitalisation of more than R650bn. It has emerged as an independent asset class worthy of inclusion in a balanced portfolio on its own merits.

Property can be a fairly volatile asset class. In 2006 the FTSE/JSE Listed Property index fell 24% in two months; in October 2008 it fell 16% in a short period. More recently, the cabinet reshuffle has brought some uncertainty, which is not good for property. If investors cannot stomach this volatility, a better way to access this attractive asset class is through a wellconstructed multi-asset-class or balanced portfolio.

What makes these popular is their central decision-making, flexibility and ability to diversify among various asset classes. Traditionally, these portfolios invested in growth assets, such as local and global equity, and fixed income assets, such as bonds and cash. More recently, property has played a larger role in them.

Why invest in property? Property provides diversification benefits as it is either uncorrelated or has low correlation to most asset classes. It can therefore reduce risk in a portfolio without necessarily reducing the return potential.

The accompanying chart illustrates this point.

Its attractiveness becomes clearer when its total return is divided into income and capital components. The income return from property historically has been higher than equity dividends and the trend is expected to continue. Most South African property companies are organised as real estate investment trusts, which have to distribute almost 100% of their earnings to investors. Pay-out ratios for listed equity companies are typically lower than 50%.

The capital return has also been attractive as property companies have been successful in merger-and-acquisition activities in and outside SA. While the early focus was on acquiring smaller players to bulk up, over the past 10 years it has been on diversifying into other countries — mainly Europe, Australia, the US and the UK. Around the same time, the depth and knowledge of property investors in the South African market became appealing to offshore companies looking to raise capital. This trend introduced a rand-hedge element to the asset class’s attractiveness. The low-interest rate stance adopted by most central banks since the global financial crisis has also provided a tailwind for property.

How much to allocate is a key question as it often determines the expected potential returns from a portfolio. There are various ways to approach this. We prefer to use quantitative methods, combined with a qualitative assessment using industry knowledge and the macroeconomic environment when deciding on an appropriate allocation to property.

Although the property universe of shares has grown, it is still very small and illiquid compared to equity securities and fixed-income instruments. We are comfortable with an allocation of 5%-15% to property depending on the portfolio’s objective. This allocation can be split between South African and offshore property. As SA’s property market has more than 35% exposure to indirect offshore earnings, stock selection is important as is how these stocks blend with other assets in the overall portfolio.

Property plays an important role in a multi-asset-class portfolio as its unique features make it an attractive asset class. However, it is imperative to have an appropriate allocation to the asset class considering that its high returns historically have come with higher risk.

THE DEPTH OF PROPERTY INVESTORS BECAME APPEALING TO OFFSHORE COMPANIES LOOKING TO RAISE CAPITAL