Investing in property internationally makes perfect sense from a diversification standpoint and especially in the current political and economic climate in South Africa. South African cap rates have softened significantly but the considerable equity created in the property sector since 2002 is still heavily exposed to the South African market and currency. As a result, many large players in South Africa are investing internationally in both direct and indirect property.

Direct property internationally is currently very attractive for South Africans able to fund the significant equity required to ‘do deals’.

In the UK specifically, the credit crunch has made sourcing funding far more expensive in recent months. “All in” lending rates on quality assets in the UK are now in the region of 6.9% (based on a UK swap rate on June 4 of 5.62% to 5.66% and a 125 basis point spread) and the underlying properties have correspondingly become much cheaper.

Equivalent yields in the industrial sector, countrywide, have softened from 5.4% in the first quarter of 2007 to 6.8% in the first quarter of 2008, a drop of 25.9% for similar income streams. Some specific areas in the UK have softened further with equivalent industrial yields moving from 5.7% to 7.3% in the North East and 5.4% to 6.9% in the East Midlands over the same period. (*Industrial statistics obtained from CBRE Research UK on prime industrial property from 10 000 to 20 000 square feet in size).

Many prime properties in first world economies (as with the UK) have ‘all in’ lending rates significantly lower than equivalent yields (a smoothed combination of the net initial yield and the yield at the first reversion) and often lower than initial yields as well. Although the jury is still out as to whether the markets have further to fall, this represents a buying opportunity for South African investors.

The choice then between direct or listed property becomes an interesting one. Pertinent factors for direct property include the pros of complete control, the ability to hand-pick investments, a lower change of margin calls by funders if cash flow remains positive and payments are met and lower levels of volatility. On the down side however is the illiquid nature of direct property, the requirement of a more complicated structure for ownership, high exposure to a single or a few assets and, if leases are not long and strong covenants, active management will be required.

On the other hand, listed property is currently trading at a discount to net asset value (specifically in the UK and European market), is easier to understand in terms of market pricing, offers liquidity and needs no hands-one management. However when investing in listed property, it is riskier to gear and more volatile, with the price behaving more like a share than the underlying property, and you also do not get to select the properties in which the company is invested.

No matter which way you foresee the current direct property investment market going internationally, the diversification of first world direct property is very interesting to South Africans. To acquire a property with a long, strong covenant internationally is a good balance to investing in SA’s high risk/reward property sector with annual rental escalations of 8-10%, inflation running over 10% and base lending rates at 15% and rising.