By Melvyn Lloyd, 30 April 2013
In this article we will firstly look at the returns that the sector has produced over the past couple of years. Secondly, we will look at the attractiveness of local property vs. global property by looking at some valuations. And finally, we will look at some of the benefits of investing in global property.
We all know that the local listed property sector has had a phenomenal run over the past couple of years, but what about its global counterpart?
In the graph below we compare the returns of the SA Listed Property Index (in ZAR) to some of its global counterparts. I think you would agree with the fact that some of these global property indices have produced quite remarkable returns over the past few years. All of these global indices, with the exception of the MSCI World/Real Estate Index, have produced double digit returns over most of the investment periods shown below.
From looking at the performance numbers above, it is important to note that past performance is NOT an indication of future performance. It’s also important not to make investment decisions by “looking in the rearview mirror”.
That being said, when constructing a long-term, well-diversified portfolio - the benefits of global property as an asset class should not be overlooked.
Looking at the two asset classes from a relative point of view, some asset managers are seeing more value in global listed property than in its local counterpart. Let us now explore some of the reasons why.
In the graph below we compare the index returns of the GPR 250 REIT World Index (USD) to the SA Listed Property Index (ZAR) since 2005. Local listed property prices declined 35% from the end of October 2007 to the end of June 2008. Currently, local listed property prices are 41% higher than their October 2007 peak.
On the global side, listed property prices declined a massive 66% from their highest point in mid-2007 to their lowest point in March 2009. Currently, global listed property prices are 2% above their previous all-time high.
Having said this, it is important to note the following. Some of the global property companies went into the financial crisis with about 50% gearing. So what is gearing? Well, gearing is defined as a company’s long-term debt vs. its equity capital.
During the financial crisis share prices dropped dramatically which resulted in the assets on the balance sheets of these companies following suit. As a result gearing ratios increased as their asset base became smaller. These higher gearing ratios caused problems with banks and other financial institutions where these companies had loans. Some of these loans were structured with very strict lending agreements and limits with regards to gearing ratios.
During the financial crisis it not only became increasingly difficult for these property companies to roll-over their debt, but it also became extremely difficult for them to get access to new loans/capital.
As a result many of these companies had the following two options: One, they could either try to sell their assets, which would have been detrimental to their balance sheets, especially during the financial crisis. Or, two, they could try and raise capital on the equity market.
In reality, most of these property companies did not have much of a choice and were forced to issue equity at the bottom of the market. So, what does this mean? Well, this basically means that these listed property companies effectively sold their assets to their investors at all-time lows, resulting in them locking in a portion of this weakness.
The second component that we are going to look at is FAD (Funds Available for Distribution) yields relative to long bond yields.
If you compare the forward FAD yields of the different countries, and the globe as a whole, to their respective 10-year government bond yields, you can clearly see a bigger yield differential (difference between FAD yields and long bond yields) in the global property market relative to our local property market.
Simplistically, the bigger yield differential in the global property market means that an investor is being compensated more for the additional risk that is taken by investing in property rather than bonds.
Please note that global long bond yields are trading at record low levels which is resulting in artificially high yield differentials. If, and when, global bond yields revert back to more “normalised” levels, we will start seeing more spread compression.
If you look at the graph above you will see that the local property sector is the only sector that is trading at a negative yield differential. That being said, it is important to note that the local property sector can at times trade at a yield lower than that of long bond yields. This is mainly driven by our higher income growth rates which are underpinned by average escalation rates of 8% pa.
As a result of our higher income growth rates, investors are at times willing to accept a lower income yield. So in SA you will typically find that at times of high income growth, yields will trade at or even below long bond yields and when income growth rates are low, yields will trade at or above long bond yields.
Now that we have looked at some of the returns of global property as well as the attractiveness of global property vs. its local counterpart, let’s now turn our attention to the benefits of investing in global property from a local investor’s perspective.
Firstly, investing in global property can provide a hedge against rand depreciation. Since the start of 2011 the Rand has depreciated by a whopping 37%. From the beginning of 2011 to the first week in April 2013 the USD return on the GPR 250 REIT World Index has been 40%. Over the same period this index (in Rands) produced a stellar return of 91%.
Secondly, by investing in global property you can diversify your portfolio’s currency risk. If you’re a local investor and you invest in a global property fund, you’ll get exposure to quite a diverse range of global currencies. This means that your returns are not only a function of the Rand’s movements relative to one currency, but rather a spread of global currencies. If you look at some of the rand denominated global property funds, you’ll find underlying exposure to currencies such as the Australian Dollar, Canadian Dollar, Swiss Franc and Euro to mention a few.
Thirdly, you get access to additional property sectors and stocks: Traditionally, local property investors only had access to the retail, industrial, and office sectors. Global property investors not only have access to these sectors but they also have access to sectors such as healthcare, self-storage, apartments, forestry, student accommodation and data centers.
And finally, diversification: Global property can add additional correlation benefits to your investment portfolio. Please see correlation matrices below.
From the three correlation matrices above you can see that over the last 10 years (first table) global property’s correlation to other global and local asset classes has been relatively low. This is even more evident when compared to the local asset classes, where global property has at times even registered a negative correlation.
As a result of the low positive, and in some cases, low negative correlation relative to other asset classes - global property can add significant correlation benefits and as a result, diversification benefits, when constructing a well-diversified portfolio.
At the end of the day no one knows if global property will be able to produce the stellar returns that investors have become accustomed to over the past couple of years. One thing we do know is that exposure to global property should not be overlooked when constructing a well-diversified portfolio for the long term.