Bonds, listed property not in same basket

Despite recent results in the listed property sector - either meeting or exceeding expectations - the performance of property stocks has been at the mercy of bond markets, which have generally been weak and volatile since mid-May.

The global search for yields over the past few years has produced a close correlation between bonds and listed property, which are both yield-bearing investments. Local bonds and listed property stocks have been volatile since US Federal Reserve chairman Ben Bernanke said in May that the Fed would reduce its monthly bond buying, or quantitative easing.

Growthpoint Properties's chief executive Norbert Sasse said last month the listed property sector, including Growthpoint, would have to take continued share price volatility in its stride amid a structural shift in global bond yields.

Declining bond yields expected

This is despite the fact that the fundamentals of Growthpoint's business are strong, Sasse says after the company achieved distribution growth of 7.2% to 149c per linked unit for the year to June.

In the wake of the Federal Reserve's surprise announcement on Wednesday last week (18 September) that it will continue buying US bonds at a rate of US$85bn a month, both the rand and local bonds have strengthened.

While analysts say declining bond yields and interest rates over the past few years have fuelled the listed property sector's exceptionally strong run, some analysts say that while a bond-property correlation is warranted, property stocks have equity attributes including capital growth and should therefore behave as hybrids of bonds and equities.

A listed property financial director, who did not want to be named, said his fund sees two types of investors.

"One invests in bonds and property for pure income returns, while the other, usually pension funds, invests in property funds on a long-term basis to generate both capital and income returns," the director said.

Yields rallying

Grindrod Asset Management chief investment officer Ian Anderson says listed property's 5% rally in the week ended 13 September was in response to a stronger rand and lower bond yields, both globally and locally. As a result, the forward yield on the sector declined to 7.1% or about 70 basis points below the yield on longer-dated South African government bonds.

Anderson says most investors compare listed property with bonds, only looking at the income yield the asset offers.

As listed property tends to be riskier than government bonds, which have guaranteed income streams, property yields are reasonably high.

However, Anderson says what investors tend to forget is that unlike bonds, listed property has a growing income stream, which makes shares more valuable and buoys prices.

"While the yields have been highly correlated over the past 10 years or so, the actual returns from listed property have been about 15% a year higher than the bond market," he says.

Between March 2003 and July this year, total returns on the South African listed property index was 25% annually, while total returns on the all bond index was 10% per year.

Equity risks

This implies a 15% equity risk premium. Anderson says as the sector should only out-perform bonds by 5% or 6% a year, listed property yields need to be significantly lower than they are today.

"There's a strong argument to be made that the yields on listed property securities should be quite a bit below the yields on bonds. The extent to which they are lower is dependent on how much investors think the income can grow," he says.

"Higher income growth will translate into bigger yield differentials, while zero income growth will see listed property yields being above bond yields due to the inherent risks in the income stream," he adds.

Anderson says the best proxy for listed property over time would be inflation-linked bonds. He expects listed property's distribution growth to average more than 7% a year over the next three years.

"This should support medium-term capital growth, although the risks associated with rising global bond yields are likely to persist in the short term," he says.

While some investors are expecting only 4% or 5% income growth in the years ahead, he expects growth to be higher than this due to changes in the industry such as the introduction of the real estate investment trusts (Reit) structure, and companies borrowing more debt and internalising management functions.

"Higher growth support slower yields," Anderson says adds.

Source: Business Day via I-net Bridge