A strange phenomenon has set in onto the JSE listed property sector causing followers of quoted property funds into a moment of pause.
The sector has in the recent past taken some serious beating. It depreciated by about 20% between May and June. While it has recovered some of the lost ground, the JSE listed property sector has bled more than the equities on the JSE amid generalized volatility of the past few months.
The cause of this volatility can be traced to the jittery global markets and mainly uncomfortable noises emerging from the US. News that Ben Bernanke, the chairperson of the Federal Reserve was mulling a stop to printing dollars caused an investor panic. This translated in a flight to ‘safe havens’ and out of emerging market assets. In that way, the rand was hammered and so were local bonds.
In the hammering of bonds, came the slide of the JSE listed property sector which was disproportionately deeper than the depreciation suffered by local equities but much better than the battering taken by the bonds. There in, stands the conundrum. It is beautifully captured by Evan Robins the manager of Old Mutual SA Quoted Property Fund.
In the latest Old Mutual Investment Group quarterly investment report, Robins noted that while the JSE listed property sector has fallen from its highs in May, it has gotten off relatively lightly on the whole, considering the level of increase in bond yields.
Robins also noted that as bond yields have corrected from expensive recent levels, this has reduced a key risk to listed property which was vulnerable to such a correction. However, Robins expressed surprise that property had not reacted more severely to the bond market correction. This is because listed property which comes with an income investment play tends to track bonds.
“This cannot be explained by fundamentals as these did not improve, nor can it be ascribed to inflation concerns as property also became more expensive in comparison to inflation-linked bonds,” said Robins.
”If property had reacted fully in line with bonds, the sector would have fallen an additional 10 percent. A significant question is whether we now have a new spread level between bonds and property, or whether the current situation is an aberration.”
Robins also noted that “Listed property is essentially a hybrid sector that should be viewed as part bond and part equity. In contrast to bonds, listed property has become cheaper relative to equities as it was property that sold off more”.
In addition, Robins said the increase in the cost of capital faced by listed-property funds could be a ‘game changer’ for the sector. “Acquisitions now need to be funded more expensively which means these will be less beneficial to funds,” he explained. “This, in turn, could put pressure on direct property valuations as funds can now “afford” to pay less as their funding costs are higher. Capital raises and new listings may also become more difficult, although these will continue.” He however stressed that the cost of capital remains low even if it has risen.
When it comes to the current operating environment, Robins noted that the market has been very tough for a number of years. “Considering this challenging environment, listed property has fared well and management teams are battled-hardened”. “The office sector remains a concern and vacancies continue to rise with new offices being built for relocating tenants. What is more, a key office driver is employment, and poor job growth is not positive in this regard.
“That said, the retail sector, to which the listed sector has the largest exposure, remains robust with shopping centres doing well. However, new and often large developments continue to cannibalise existing centres and the health of the consumer cannot always be taken for granted.”
Regarding Real Estate Investment Trust status (REITs) legislation, Robins believes that the biggest implication of this will be an increase in corporate action, as REITs do not have capital gains tax liability and provide roll-over relief. “As a result we expect this to trigger further property fund mergers, disposals, sales and purchases of equity stakes in other funds, and acquisitions as some vendors may have a tax incentive to sell to a REIT rather than a non-REIT.”