Market Review

The SA Listed Property Index (SAPY) returned a total of -1% in the third quarter of 2018, actually outperforming equities (-3.3%) but still lagging cash, which still delivers positive nominal returns even as risk assets have declined in absolute terms. Year to date (YTD), the SAPY has materially underperformed all other domestic asset classes, returning -22.2% YTD versus -8% for general equities and about 5% for cash.

The best performing shares in the SAPY for the quarter included Echo Polska (18%); Equites (13.6%), Fortress A (10%) and MAS Real Estate (9%). In contrast, the worst performers were Accelerate (-16%), Growthpoint (-13%), Rebosis (-13%) and Hyprop (-10%). However, some of the negative moves in the worst performers were exacerbated by them paying out dividends in the quarter.

Contributing to the negative returns for these shares were a number of SA-focused mid- and smaller caps reporting weak distribution growth and even weaker (declining in some cases) forecast distributions, such as Accelerate, Rebosis and SA Corporate, while even larger caps like Growthpoint and Hyprop reported and are targeting low single-digit growth rates.

Performance and actions

The current quarter was again very quiet on the corporate action front.

With the September 2018 FTSE/JSE SAPY rebalance Greenbay Properties was replaced by Stenprop and the weightings of Fortress A, EPP N.V and Equities Property increased while Vukile decreased in the SAPY index. The one-way turnover was somewhat higher than usual at 3.4%.

Your fund performed in line with the SAPY benchmark. The fund experienced some positive cash drag year to date, due to the index being in the red over the last nine months.

Outlook

Following the weak YTD returns, the SAPY has derated from a 6.8% clean forward yield at end of 2017 to an attractive 8.6% trailing income yield and a clean forward yield of about 9%. The forward yield is at a slight premium to the SA long-bond yield of 9.1%, which itself derated this year as Ramaphoria faded and amid general emerging market weakness on account of an impending trade war.

We consider these levels, in absolute terms, to be in buying territory again, and certainly relative to SA cash. The income yield alone is over 3% higher than inflation expectations, and over 1% higher than cash rates. With the SAPY also likely giving growth in dividends (unlike cash and bonds) of CPI in the long run (4% to 6% p.a.), buying at the current price levels may make for a total medium- to long-term (three to to five-year horizon) expected return of 13% to 15% p.a.

There are also some fundamental headwinds that could take time for the abovementioned expected return to be realised. Some of the smaller REITS have cut their distribution outlooks, in some cases to negative growth. In terms of how this weaker outlook for property distributions may have materialised, even supermarkets like Shoprite are struggling to grow earnings (earnings down 3%), highlighting a tough SA economy.

However, the sharp derating to the high-income yields of 9% to 10% for SA-focused shares hopefully provides an adequate cushion for the above considerations.

Market Review

The FTSE/JSE SA Listed Property Index (SAPY) delivered a total return of -19.6% during the three months to the end of March 2018, mainly due to company-specific concerns. Relative to other asset classes, the SAPY materially underperformed equities (FTSE/JSE All Share Index: -6.0%; cash: 1.8%; bonds: 8.1%) over this period. On a rolling 12-month basis, the sector’s total return is -7.1% due to the negative first quarter of 2018.

Due to the idiosyncratic nature of the SAPY’s performance for the year to date, the typical correlation between property stocks, government bonds and the forex market has broken down.

The best-performing shares in the SAPY for the quarter included the likes of higheryielding domestic mid-caps such as Accelerate, Arrowhead and Emira, as well as larger caps such as Growthpoint and Redefine, all materially outperforming the index with returns of between 5% and 15%. The rallies in these domestic names were driven largely by the change in the SA presidency, which in turn drove our local bond yields lower and the rand stronger. Of the rand hedges, Echo Polska also rebounded this year (about 10%) after its sell-off in 2017 on news of a director being arrested.

By contrast, the worst-performing shares in the quarter (which drove the average index down close to 20%) were the shares which were by far the best performers in 2017. Their sell-off was very dramatic, offsetting all the previous year’s gains and more. The derating of Resilient, Fortress, Greenbay and NEPI Rockcastle - on concerns that these property counters entered into off-balance sheet loans, crossholdings between the entities, possible insider trading, and aggressive capital raising at high multiples - explains the decline in the SAPY index. A rough estimate is that the SAPY would have delivered a return of about 3.5% excluding the four companies in question.

While there may be merit to the above concerns and hence a sell-off in these shares were justified, perhaps it has taken these particular shares, but also the average index with it, from one extreme (overvaluation) to the other (undervaluation).

Performance and actions

The quarter was very quiet on the corporate action front. With the March 2018 FTSE/JSE SAPY rebalance there were no additions to or deletions from the index, but the weightings of MAS Real Estate and Echo Polska increased while Resilient decreased in the index. The one-way turnover came to 0.7%.

Your fund outperformed its benchmark slightly mainly due to cash holdings in the portfolio (strong down market).

Outlook

Following the weak first-quarter returns, the SAPY derated from a 6.8% clean forward yield at the end of 2017 to well over an 8% clean forward yield, with a twoyear expected growth in dividends of about 7% p.a. and, in our view, longer-run growth in the CPI range of 4 - 6% p.a. This yield is now, for the first time in quite a while, at a discount (i.e. above) the SA long bond yield, which has rerated to around 8%.

At a macroeconomic level, a further 25-basis point cut (50 basis points over the past year) in domestic interest rates also benefits the sector. Indirectly this makes other competing asset classes, such as cash and bonds, less attractive for investors, which could lead to increased demand for riskier assets such as property and general equities.