Listed property: A core holding in any balanced portfolio

The SA Listed Property Index (J253) recorded a total return of 8.8% over the one year period ending December 2011 and delivered a return of 3.73% over the final quarter. This impressive rally has continued into 2012, with year-to-date property share returns of some 7.3%. What is driving this growth?

The legislation helps on two fronts: First it allows local investors, fund managers and advisors to gain an understanding of the asset class, and second, it ensures greater comparability for foreign investors into the sector. Tax uncertainties created by the different structures will be removed by the introduction of the REIT legislation too.

The old system of having separately listed property loan stock (PLS) and property unit trust (PUT) instruments created confusion for investors who were unaware of the differences in both the gearing of and distribution requirements associated with these types of investments. The new legislation will address the dominance of PLS such as GrowthPoint, Redefine and Hyprop, which drove the sector’s overall performance.

Local property returns fared exceptionally well relative to global property markets, largely because access to commercial property funding has dried up in the UK, US and Europe. South African property returns benefited from an improving distribution profile and sound management of core costs.

Retail sales – the leading indicator for retail property vacancies – continue to be positively driven by new mall expansions and discretionary spending. This is one of the reasons why retail properties are preferred over commercial and industrial opportunities to gain exposure to the sector.

Retail vacancies remain the most stable of the sectors and look set to attain the highest rentals in the near term as supply catches up with demand in certain regions. In the office sector, although supply is also catching up with demand in certain areas, we are cautious on B and C grade (lower quality) office rentals. Positive rental reversions are expected from offices in 2012, when most property company leases come up for renewal.

Industrial vacancies are lagging both the retail and office sector and current increasing levels of capacity utilisation and weaker export growth mean that the recovery in industrial vacancies is likely to be delayed. There is currently good demand for distribution warehousing space in the industrial sector.

While cost push pressures (property rates, taxes and utility charges) and a softer property market are likely to be short-term constraints on distribution growth, longer-term property fundamentals are very healthy.

Stabilising vacancies and improved rentals, together with nominal distribution growth of 6% to 7% per annum, are strong catalysts for a re-rating of the sector. In addition, the forecast risk for properties tends to be lower than equities due to the "long tail” nature of leases and secure rental escalation streams.

New property developments in office and retail should be sufficient to match current demand and the one-year average property distribution yield of 8.3% compares favourably with that on offer from cash and bonds. The outlook for property is buoyant, with 12.5% compounded annual returns expected over the next five years. Listed property should thus be a core holding in any balanced portfolio.