Bright prospects for listed funds

12-12-2005

Solid income-stream growth and marginally declining income yields are sending listed-property prices soaring, according to the latest Rode's Report.

Rode points out that the mooted increase in short-term interest rates next year has not yet had any effect on long-bond yields. The report predicts that it is not expected to impact negatively on listed funds' income yields, either. [When income yields rise, prices decline.]

Mindful of the fact that the property cycle has historically been a long one, and that interest rates are expected to remain relatively close to their current levels over the next few years, the report expects the non-residential property boom to last a number of years, and therefore sees listed funds' income yields remaining stable.

"Other factors supporting low and stable income yields are the expected peaking of the residential property cycle and perhaps, as we've seen more recently, an increase in foreign interest in listed property", says the report’s editor, Garth Johnson.

Johnson identifies the future movement of gilt yields as the only remaining wild card, considering that gilt yields are correlated with the income yields of listed property.

"On the one hand, interest rates internationally are heading north, but on the other, South Africa's treasury does not have a strong need for new issues, given its sound finances."

According to the report, these stable conditions are likely to give listed funds the leeway and the confidence to pay more for directly-held properties and, hence, reduce capitalization rates further in the process. Capitalization rates reflect the sentiment and expectations of long-term investors in a relatively illiquid asset (real estate); but they do not adjust to every movement in the economy as the income yields of listed properties are prone to do.

With the exception of regional shopping centres, which took a breather, capitalization rates continued trending down during the third quarter. With long-term inflation expectations remaining within the Reserve Bank's target range, and the prognosis for income growth remaining good, capitalization rates are likely to continue on the down path in the coming quarters.

The average leaseback escalation rate was 8,4% during the third quarter of 2005. Considering that the escalation rate is an attempt by the market to forecast market rentals until the expiry of the lease, and given the fact that leaseback terms are typically 10 years, the Rode team considers a compounded growth of 8% over that term to be high, in view of inflation of, say, 5% per annum. However, for leases of 3 to 5 years, they see the current 8% escalation rate as a more accurate, if conservative, estimate of the future movement of market rentals.

On the industrial front, rentals are still racing ahead, in spite of the deceleration in manufacturing production since the start of the year. Although the deceleration is reflected in a decrease in manufacturing capacity utilization, all is not bleak: manufacturing capacity utilization is still at healthy levels and should remain so over the next few years if economic growth continues at predicted levels.

Industrial rental in most cities managed double-digit year-on-year growth during the third quarter of 2005, but Port Elizabeth put in a disappointing performance, with its rentals continuing to move sideways for the third quarter running.

House prices are continuing to lose steam, and even though house prices in the third quarter were still almost 20% higher than a year earlier, annualised quarter-on-quarter house-price growth was a much lower 12,4%. Rode's Report predicts continuing deceleration as a result of declining demand on the back of increased unaffordability coupled with a limited ability by consumers to significantly alter their spending patterns.

During the first quarter of 2005, the prices in lower-priced suburbs were still growing faster than those of middle-priced and upper-priced suburbs. But Rode's figures show that lower-priced houses still have some catching up to do relative to other price classes. R100 invested in a lower-, middle-, and upper-priced house at the beginning of 2000 would have grown to R186, R217, and R205 respectively by quarter 2005:1. Whether or not the low-priced category will continue to outpace the growth rate of the higher categories, as it has been doing over the last few quarters, remains to be seen.

Flat rentals grew at nearly double the rate of inflation over the past 10 years. In Johannesburg, 2-bedroom rents are currently the highest at around R2.800 per month, while Port Elizabeth has the lowest at R2.000. Two-bedroom rentals in Pretoria, Cape Town and Durban are in-between, at about R2.500 per month.

Grade-A office rentals climbed further during the third quarter of 2005. On the whole, decentralized rentals were up 5% on a year earlier, while CBD rentals were almost 12% higher than at the same time last year. Nonetheless, real rentals have continued to decline, dampened by high building-cost inflation.

Optimism in the building industry remained elevated during the second and third quarters, according to recent surveys. Supported by solid growth in the number of buildings completed and plans passed during this period, upward pressure on building costs continued.