The decade-long world property boom has ended abruptly, with listed fund share prices falling 36% in Britain, 25% in Europe, 17% in the US and 10% in Australia in 2007. Australian listed shares fell another 12% in the first two weeks of 2008.
Against this trend, South African funds have sailed through their seventh year of energetic growth, rising by nearly 20% in 2007. Most analysts expect them to continue defying the pull of credit-crisis gravity for the next few years - but others warn that early signs of a local correction are appearing.
The JSE's property sector has fallen 4% since the beginning of the year after a 1,7% fall in December. Does this back the pessimists' fears, or is it merely a sympathy move with the rest of the equity market, a pause for eager investors to buy on this weaknesses and push prices up again?
At an income yield of about 7,4%, the SA property sector is trading at around 100 basis points lower than the government 10-year bond, the R157, which is at 8,4%.
By contrast, UK and European funds are trading at 200 points, and Australia 100 points, above 10-year money, says independent property analyst Ian Anderson, pricing in property's relative risk to government.
"UK-listed property companies are trading at 35% discounts to net asset value (NAV), while the SA companies are at a 15% premium to NAV," he says.
If SA's listed property sector were to trade in line with Europe and the UK - that is, start trading on a forward yield 200 basis points above government bond yields - that would imply capital losses of about 30%, says Anderson. The sector's market capitalisation would fall from R100bn to R70bn, and forward yields would rise to just below 11%.
Catalyst fund managers analyst Paul Duncan says First-World property yields at between 6% and 7% are not that different from SA's 7,4%.
"And in Hong Kong some yields are between 8% and 11%," he notes.
So why should SA be out of step with the rest of the world? asks one property investor. Like others, he is frustrated by the consistently low returns offered by SA funds, despite a series of interest rate rises that would normally have pushed yields up and prices down.
The answer is that SA is marching to a different drum, say Duncan as well as Macquarie First South property analyst Leon Allison. We are at the early stages of a commercial property boom, while most global property cycles are mature.
"Investors see the real potential for recession in most other countries," says Duncan, "with rents stagnating or falling, while our economy is expected to grow by 4%- 5%. And rents are increasing by 20% and even more on reversions (the signing of new leases)."
Allison agrees that rentals and shareholder payouts will continue to rise strongly for two to three years.
It's this growth expectation that also justifies the sector yield discount to government debt.
Says Duncan: "In 2004, when property yields were 9,8%, long bonds 8,15% and cash 7,33%, payout growth was 5% - below inflation. Now, when cash is 10,94%, long bonds 8,81% and property 6,92%, payouts have grown 16%."
Duncan notes that though their starting yields may be 7%, investors have calculated that rental and payout growth will give them a 10-year property yield of nearly 15%, which is a good risk-adjusted return compared with the long bond (see table). And capital growth is likely to grow with it unless forward yields drop dramatically.
"Funds in many other countries are also highly geared, and incomes could be damaged by falling rents," says Allison. "But SA's listed property has an average gearing (debt to property value) of around 20%.
"The interest rate on most of that debt is fixed and terminates in line with leases, so payouts will hardly be affected by any further interest rate increases this year."
By both Duncan's and Allison's reckoning, all property fundamentals are extremely strong. But they see two external factors that clinch the argument for continued growth in SA-listed property values. First, there are structural supply constraints to the supply of more property space to meet the constant demand of a growing economy.
Construction and professional skills have been diverted to meet government infrastructure needs like the Gautrain, the World Cup stadiums and Eskom's expansion. Building costs have been rising faster than rents and, together with higher interest rates, are constraining new developers.
Lack of local government skills and capacity make approvals for new developments very slow. There is a shortage of zoned land and authorities are even slower at taking zoning through approval processes.
All of these will underpin rapid rental rises in the years ahead.
In addition, pension funds have chosen to gorge themselves on listed property.
"Anecdotal evidence indicates that many pension funds are looking at dedicated property exposure of between 5% and 10% of their assets," says Duncan.
"Until now, listed property fell into the fixed-income component of the investment manager's mandate and was probably around 2% of assets.
"The Public Investment Corporation has been the most active participant here."
Even so, Duncan and Allison concede that the exceptionally low forward yields of the sector are driven at least partly by sentiment - investors are buying in the expectations that rents and payouts will rise fast and give them juicy income streams in the next few years.
If sentiment changes, yields could start rising and prices falling. A moment will come, if interest rates continue rising, when investors return to their traditional approach to property. This could trigger a big share-price fall.
There are sound reasons why prices could fall, despite the fundamentals. UK-based Mike Watters, CEO of Ciref (which is SA-controlled but London-listed) warns that SA investors may not be valuing our funds properly, which would mean relating them to global funds.
"The current yields discount substantial growth in payouts over the next few years, but do they take into account the inflation rate differential between, say, Britain and SA?" he asks.
UK inflation is just over 2%. SA inflation is about 8%. Adjusted for inflation, UK funds look much more attractive than SA's and, priced for this differential, SA funds should be a lot cheaper.
"It's impossible to say what will happen with the current global instability, and, of course, prices could fall," says Duncan. "But income growth looks secure, and that is what property investors focus on." That, however, may also turn out to be optimistic.
The biggest mistake analysts could be making is to take for granted that supply will be constrained, thus underpinning the rapid income growth. A number of developers are already saying they see too many office buildings going up on land that has zoning.
The 2007 third-quarter office vacancy report from commercial property organisation Sapoa shows that developers are committed to nearly 600 000 m² of new office space, and more than 75% of that is being built speculatively, without tenants lined up. A lot more is said to be in the pipeline.
A growing number of empty offices will mean that the much-vaunted rocketing rental growth, on which current prices are anchored, could suddenly come to an end.
As surely as night follows day, property booms are followed by oversupply and declining rents.
Yet the industry does not appear to be tracking too seriously what is happening to that critical supply.
