Are SA Listed Yields Still OK

Posted On Tuesday, 29 March 2005 02:00 Published by eProp Commercial Property News
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Earnings growth potential remains critical to the health of the listed property sector.

Property-Housing-ResidentialEarnings growth potential remains critical to the health of the listed property sector; especially now that listed yields and long bond yields remain closely knit.

Under most scenarios, one expects listed yields to be slightly higher than a risk free 10 year long bond rate – the norm over time internationally and locally is around 200-300 basis points.

This premium can be attributed to ‘property risk’ that can include direct property risks, earnings growth and management among others. Both in SA and the US this differential is significantly smaller or, from time to time, non-existent.

More recently, listed property has clearly moved into the arena of income distribution or dividend growth. Dividend growth forecasts are on average around the 4% level but over the next 1-2 years certain funds have even higher projections.

This being the case, one of the critical risk factors includes establishing whether a particular fund is subject to any negative reversions (escalated rentals renewed at lower market rentals). This is particularly pertinent for non-speculative or longer-term investors that listed property is inherently suitable to.

This being said, there is little doubt that there are opportunistic buys in the sector and there is the risk that speculation could push up share prices to unreasonable levels.

For investors the time frame horizon becomes important, and since certain shares may appear expensive at present when looking at price relative to short-term earnings, one must factor into account the sustainability of earnings growth into the long term or perpetuity.

At the moment the I-Net recommendation on the largest available fund is a buy; this even though it trades at a substantially higher PE ratio of nearly 30 than the overall sector average (weighted sector average 20 with most funds trading in the 12-16 range).

Clearly whilst this may appear to indicate an overheated share price scenario, their outlook nevertheless would include a view on the fund’s risk premium, management and so forth.

With prime direct property capitalization rates around the 10% mark and most listed funds trading at forward dividend yields of 7%-10%, earnings enhancing acquisitions are still possible though increasingly difficult in the context of limited supply and growing competition.

Some analysts are also cautious on growth resulting from development and trading activity, rather preferring to see sustainable distribution growth. With listed property yields having practically merged with that of the long bond, we get back to the initial question of whether this low yield level is sustainable and justifiable.

Two factors will determine this – namely short-term interest rates in the context of monetary policy and property fundamentals.

On both counts the forecasts look promising – stable rates and improving fundamentals - and so we can expect that this correlation will continue over the next while.

However, bond yields appear to have bottomed out and so one wonders whether a further drop in listed yields can occur and whether there is the risk that listed yields will need to adjust, thus potentially leading to negative share price adjustment.

At the moment the market will be satisfied that listed yields remain at a slight premium to long bond yields. On account of earnings growth prospects driven by market fundamentals, any narrowing yield risk is of no real concern.

Also, one must appreciate that listed property is by in large an income buy and so investors should not fixate too much on the share price perse, as appealing as it’s performance has been over the past few years.

Last modified on Monday, 12 May 2014 14:18

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