Two of SA’s biggest asset managers have sharply reduced their exposure to the listed property sector.
Marriott and Coronation have taken profits on one of the hottest sectors on the JSE in the past two years and raised the question whether the commercial property market is topping out
Marriott, with assets of R20bn, has reduced its exposure in the listed property sector because it expects a rise in interest rates.
CEO Simon Pearse disclosed that Marriott’s Property Equity Fund has scaled back its exposure from 85% to 50%. The Core Income Fund reduced its exposure to 20% from 50% and the Income Fund to zero.
“We have reduced our exposure to property to give investors the flexibility to choose an appropriate level of property exposure in the light of an expected rise in interest rates.”
Marriott expects inflation to increase to 6% next year and rates to rise by one or two percentage points owing to high oil prices, imported inflation due to rand weakness and government’s desire to slow local borrowing, which is at record levels.
Pearse says this action (reduced property exposure) will reduce capital risk but will not affect income per unit, as a rise in rates will increase income.
He explains that property yields are currently similar to cash yields of 6,5 to 7% and are one percentage point below bond yields of 8%.
“It is likely that property yields will close the gap with bond yields and rise two percentage points,” says Pearse. “This would mean a decline of about 25% in property prices.”
Coronation also reduced its exposure from 100% of its fund to 75%. Edwin Schultz, Coronation’s fund manager, says this decision was taken because property yields were not outperforming cash deposits.
He disclosed that Coronation was a bit cautious on listed property, “but not as bearish as Marriott”.
Said Schultz: “We disagree with their economic assumptions on inflation and interest rates and it is unlikely that property prices will drop by 25%.”
“There are still attractive stocks such as Hyprop with its quality retail portfolio and Growthpoint with its excellent spread of assets,” he added.
Tony Bales, director of property investment company Bales Delaporte, says investors need to take into account the mathematical-percentage effect of a one percentage point rise in interest rates.
“Previously a one percentage point change came off the back of, say, an average 15% - that made a difference of just over 6% to cash flow. Now the prime lending rate is only 10,5% and a one percentage point change has a far greater effect (9%) on one’s cash flow,” explains Bales.
“The listed property sector has enjoyed a buoyant three years on the back of declining interest rates,” adds Bales. “Now investors have to be cautious because the returns of the past three years are unlikely to be repeated.”
The property index produced a total return (income and capital appreciation) of 2,23% in October bringing the year-to-date return to 37,74%. Last year the sector returned 41% to unitholders.
Chris Naidoo, fund manager at Metropolitan Asset Managers, who concedes that the listed sector has had a phenomenal run and that it may be time for a pause, echoes his sentiments.
“But as long as interest rates are stable, the sector has more to go,” says Naidoo, adding that MetAM has not lightened its exposure to property.
Andre Stadler, an analyst at Catalyst Fund Managers, says his fund has also not reduced its exposure in the property market.
“There is still value in the market, particularly on the income-growth side,” said Stadler. “The strong demand for space has pushed rentals up and this would boost income even if interest rates go up.”
Christian Hansen, director of Investec Listed Property Investment, also disagrees with Marriott’s economic assumptions. “We feel interest rates would remain flat for the next 12 months and this would stabilise prices.”
Hansen says the fund is not bearish on the market owing to earnings growth in the sector of 7% to 8%. “This would translate into capital protection and growth because share prices follow earnings growth.”
According to Hansen, the fundamentals of the market are still intact given the strong demand for space, declining vacancies, rising rentals and good GDP growth, which came in at 4,2% in the third quarter.
Leon Allison, an analyst at First South Securities, attributes these recent moves to profit taking. He argues that property yields at 7% are above cash yields. Allison believes that property will outperform bonds and cash in the next 12 months.