For a lot of people, the term investment is often synonymous with property, be it a second home, a rental property or exposure to a property unit trust as part of their investment portfolio.
Terms like “safe as houses” have fallen into the same category alongside the old idea of buying of a policy with one’s first pay cheque – things prudent people do when wanting to save.
For the past 3 years however, a large portion of the flagship fund managers have been avoiding property in their balanced funds and yet this asset class has continued to be a stellar performer. Now were each of these managers wrong with the call or did the property sector just go from relatively expensive to more expensive on a valuations basis?
John Rainier, our property analyst is of the belief that local listed property is priced for distribution growth that can only disappoint going forward. Now what does this mean? Well the basic components of the return one gets from property are distributions (from rental income), and capital appreciation when the investment is ultimately sold. Now if one assumes that the rental stream is not only secure for the medium term future but is also expected to increase at a greater rate than inflation year on year, then the property investment in question is usually priced for these conditions. Fine, while it continues, but ultimately this doesn’t persist for very long. When this situation changes, a price correction follows which leads to lower investment returns for the investor based on a reassessment of the value of the rental stream expected.
John’s research showed that historic growth in property distributions has been around the 6% pa mark while the South African stock market has grown earnings at 14.5% over the same time. It is this based on these findings that we wonder why investors are still flocking to get into property investments as opposed to the equity or balanced portfolios the likes of RE:CM are running. As I mentioned in one of the previous articles, we only invest in companies where the share price is trading at a significant discount to fair value. The opposite is true of the SA listed property market at this point. It is trading at a 30% premium to the value of its underlying properties.
In summary, we believe that the returns out of this sector have surprised almost everyone, including the property gurus but when we look at the value of the underlying investments relative to the price asked for the rental streams they’re producing, we feel there is still more value in the equity market. In other words, the SA listed property market is priced for disappointment while some sectors of the SA stock market are priced for surprise.
What is never known is just how much patience is needed to wait for these adjustments to happen and we would rather lose out on further returns in this sector in the short term than lose our clients’ money by investing in overpriced assets in the long term.
