Opportunities to build a long-term portfolio, despite warnings of overheating

Two years ago, some experts were warning investors that the listed property sector had grown too fast. That was when it had a market capitalisation of less than R30bn and the average historic yield was over 11%.

So people waited for it to correct before buying, but it just kept on growing to its current market cap of R50bn and average yields have fallen close to 7% (yields fall when prices rise).

Is it too late? No. "Investor demand is now being driven by expectations of rapid rental growth as commercial property booms," says Marc Wainer, deal-making partner in Madison, SA's largest listed property fund manager, with a total market capitalisation of around R13bn.

"Management of our companies - Hyprop, Redefine, ApexHi and Prima - expects rents to rise by an average of 12%-13% as tenants renew their leases that expire over the next few years.

"Rent escalations are falling from 10% to 8,5% to reflect our lower inflation rate, so at Redefine, for instance, management is forecasting a 10% rise in payouts."

Rents are at the heart of the performance of listed property funds and the outlook for them has not been as good as this for more than 30 years in all three main commercial property sectors - factories and warehouses, shopping centres and offices.

Catalyst's listed fund management chief, Andre Stadler, agrees. "The fundamentals support the higher expectation of income distribution growth," he says. "This is driving the firming of the listed property sector yield."

He says the average "rolled" yield - the historic yield divided by the share price, less any dividend due - is 7,86%. It ranges from 6,73% from Hyprop, the R3,8bn market cap retail giant, to 10,32% for R580m market cap Miccprop. Even R2,4bn cap ApexHi A (at one time considered the highest-risk counter, but now near the top of almost everybody's list) is down from a high 17% when it launched five years ago to just under 8,5% today.

Even these low yields are about the best you will get anywhere else on the JSE today. But Stadler expects forward yields of well over 8% on average on fast-rising payouts.

Property is a long-term investment. It is also primarily an income investment, often substituting for long-dated government debt in institutional investment portfolios. Private investors should aim at income, too.

While equities might be better performers from time to time, they are also more volatile because markets and management change.

But the compounding effect of regular (if unspectacular) rising rents will ensure an excellent and steady income stream into the future.

The main weakness of the sector in the past has been management: greedy and opaque, feathering their own nests. This is being rectified by the presence of more active, transparent, professional and entrepreneurial operators. But they still need watching in the transition.

If you have R100 000 to invest in listed property, Stadler advises you to break it evenly between two types of investment.

Core investments are the blue-chip funds with excellent long-term prospects. His choices of core investments ("if you can get them") are Growthpoint (R7bn market cap, 7,47% rolled yield); Grayprop (R5bn, 7,24%); Sycom (R2,8bn, 7,49%); Hyprop (R3,8bn, 6,73%) and Atlas (R924m, 7,5%).

His "strategic" investment choices have higher yields, with some special reason for exceptional medium-term growth, but may be discarded in favour of other strategic counters. Stadler's picks are Freestone (R830m, 9,05%); Paraprop (R698m, 8,85%); Emira (R2,5bn, 8,51%); Redefine (R2,4bn, 7,69%) and ApexHi Bs (R2,4bn 9,72%).

Excluded from selecting his own stock, Wainer points to funds that are likely to outperform the rest of the sector in the near future. "Marriott is being taken over by Old Mutual Properties, so I expect them to do something with Martprop (R2,4bn, 7,92%)," he says. "I also think there will be things happening with Vukile (R1,8bn, 9,5%) and Paraprop (R698, 8,85%)."

Independent analyst Liliane Barnard notes that by buying into Redefine (R2,4bn, 7,69%) you can also get access to Hyprop (R3,8bn, 6,73%). Redefine is a hybrid fund that invests in properties and takes up holdings in other listed funds. Its 23% of Hyprop is worth R881m. This could be balanced by blue chip Grayprop (R5bn, 7,24%) and enhanced by ApexHi B (R2,4bn, 9,72%).

You could double your purchase by borrowing another R100 000 from the bank, using your R200 000 worth of property funds as security. With the interest rate on that debt at about 9%, you will earn less in the first few years, though the gearing effect will give you much higher income over the long term. But Barnard says most investors are debt-averse.

"If you do gear, you must be prepared for the bank to call up some of that debt if the interest rates rise and values fall," she warns.

Article by: Ian Fife - Financial Mail