SA’s Listed Property: Do not lose faith

SOUTH African listed property as measured by the FTSE/JSE SA Listed Property index is one of the worst performing market sectors since the end of last year, with a total return of -22.4 percent with income distributions reinvested. In comparison the FTSE/JSE Financial & Industrial index and the All Share index returned -5.9 percent and -1.5 percent, respectively.

After such a fall an investor should investigate whether the sector offers an opportunity or not.

But let us get behind the facts to understand why the SA Listed Property index index tanked. Listed properties are seen as hybrids between long-term fixed instruments and equities.

The yield of long-term interest-bearing bonds are also used as one of several measures to value unlisted property investments. When the equity market is piping hot listed properties tend to display similar characteristics as equities, such as over valuations and increased risk and over time, unfortunately, sink to more realistic levels.

From 2002 to end-2013 there was clearly a positive relationship between the dividend yield of the SA Listed Property index and the SA 10-year Government Bond Yield and the variations around the trend line tended to indicate undervalued – above the trend line – and overvalued – below the trend line – listed property prices.

From 2014 until the end of last year before the bubble popped, the SA Listed Property index effectively mirrored the price movements of the FTSE/JSE Financial & Industrial index. There was, therefore, a decoupling of SA listed properties from the 10-year government bond yield from 2014 to the end of 2017. That is what you would expect when the stock market is piping hot, which it was not.

Strangely enough, Growthpoint, the stalwart in the listed property sector, diverted significantly from the SA Listed Property index over that period and underperformed the index. Why?

The company’s dividend yield continued its positive relationship with the SA 10-year government bond yield.

With Growthpoint’s weight of 16 percent at the end of the third quarter of 2017, it means that the rest of the constituents outperformed even more.

For the investocrats – a major arbitrage opportunity opened in 2017. What it means is that you sell an overvalued share and buy an undervalued share. The gap was such that even a conservative speculator/ investor could buy government bonds and sell the exchange traded SA Listed Property index.

Hedge funds had the opportunity to build massive short positions (by borrowing shares and selling them in the market) and buy laggards such as Growthpoint shares or even long-dated government bonds.

Resilient real estate investment trust (Reit) for instance on average traded at close to a 100 percent premium to Growthpoint from end-2014 to end-2017.

Hit by short-seller

Is it then strange that the Resilient group of companies were hit by short-seller Viceroy in January this year after which an explosive report on Resilient by 36One Asset Management followed in February that concluded that the premium valuation of Resilient group’s shares arose “from insider-directed and insider-related transactions in group companies’ shares to deliberately inflate share prices and volume traded”, as the Mail & Guardian reported on February 16, 2018?

With the Resilient group saga now virtually something of the past the SA listed property sector’s rating returned to normal.

The sector’s dividend yield is again near the trend line from 2002 to end-2013 when there was a clearly positive relationship between the dividend yield of the FTSE/ JSE SA Listed Property index and the SA 10-year government bond Yield. Unfortunately, even though income growth of 6 percent is forecast for the overall sector, investors who were invested in SA Listed Property Tracker exchange-traded funds or corresponding unit trusts at the end of last year will have to wait nearly four years to get their capital back through income distributions given the same capitalisation rate of 7.7 percent today.

The 1-year forward income yield on the overall sector is 8 to 8.5 percent and compares favourably to yields on cash deposits and other shorter-term deposits.

The main determinant factor in regard to capital growth, especially in the shorter term, is long-term interest rates. If the yield on the SA 10-year government bond should rise to 10 percent, the historical trend line suggests that the dividend yield of the SA Listed Property index could jump to as high as 11 percent.

That per se would entail a potential capital loss of 25 percent. Conversely, if the 10-year bond yield should fall to 6 percent it could lead to a capital gain of nearly 50 percent or 35 percent if the bond rate falls to 7 percent.

Although investors and retirees had to endure a mini-Steinhoff, it should not cause them to lose faith in the SA Listed Property sector as a whole.

The stalwarts that stood the test of times are unlikely to do you in.

Although the Resilient Reit is trading at a forward income yield of 10 percent and sits on a discount compared to the sector, I wonder what the position will be if we are going to see class action by institutional investors against the company.