Residential property versus listed property investment

Listed property has indeed shown itself to be a top performer for investors in South Africa over the last few years, massively outperforming equity returns, for example, by 15 percent over the past three years; but could this be changing?

According to Shala Ramokolo, listed property analyst at Sanlam Investment Management (SIM), both listed property and the direct property market (the buy-to-let market) offer investors high yields, which are ideal for investors looking for regular income.

The decision whether to invest in direct or listed property rests on the profile of the individual (e.g. age, access to capital, risk appetite). Listed property stocks have equity-like characteristics, one of them being high liquidity as they are easily tradeable on the JSE. This attribute will benefit investors who may need to liquidate the stock in the short to medium term should they be cash strapped. Direct property on the contrary, is much less liquid and would therefore suit investors with such longer investment horizons, and much less need for cash in the short term. It will also suit investors with a much lower risk appetite as direct property is much less volatile (risky) that listed property.

The other benefit of listed property is its low unit value which will suit investors who do not have a lot of capital to invest. Direct property on the contrary, requires large capital amounts to invest. Only investors with deep enough pockets or with significant enough debt facilities can participate in this market.

Another consideration is that funds listed on the JSE mostly offer investors exposure to commercial property (hotels, shopping centres, offices, warehouses), and not the residential property market. Investors looking to invest in residential property will therefore need to do so directly in the market. Residential property investments may carry higher risk profiles as investors will be dealing with individuals as tenants, which may carry higher risk profiles than businesses that are the tenants in commercial property investments.

In 2010, listed property outpaced investing in direct property by a large margin, with the listed property index returning just short of 30 percent. Investing directly in property would have returned 13.3 percent in comparison (8.9 percent from the rental income, and 4.1 percent from rising property prices). Ramokolo says, “Listed property has really been driven higher by strong bond yields. As bond yields strengthened, so did listed property yields. At the same time, the sector has also enjoyed demand from foreign investors looking for yields.”

Looking ahead, SIM is estimating distribution growth of around six percent for the SA listed property index over the next 12 months, and an 8 percent clean yield. Ramokolo says that the listed property sector is now trading close to fair value but investors can still find value in the sector through stock selection.

So how does the outlook for listed property stack up versus buy-to-let? According to research manager at Rode & Associates, John Lottering, flat rentals have shown mediocre growth of two percent nationally from a year ago. House rentals are even worse at one percent, and townhouse rentals are contracting at one percent. Lottering says, “If you do opt for buy-to-let, you must make sure your income stream will outperform the interest you’ll have to pay on the bond. You need to make a good income return on the property.” He says investors can expect a gross income yield of around six percent on a flat worth R1-million, depending on where the flat is situated. That would result in a rental income of R5000 a month on a R1-million investment.
At the same time, Rode & Associates is downbeat on house price growth over the next few years. Lottering says, “There is not even a hesitant stirring (in the residential market). So while we don’t foresee a decline, growth will be moderate – certainly less than inflation. We would not advise buying a house, or any development of any property, at this stage.”

A turnaround in the property market will also be determined by an economic recovery. Economists are warning that the economy may start to slow, following a relatively strong period so far this year. Consumers are under increasing financial pressure, while the unemployment rate continues to hover around 25 percent. Property experts say a buy-to-let recovery may therefore only materialise at the start of the next interest rate cutting cycle, which could be a number of years away yet. As a result, Lottering also prefers investing in listed property in comparison to direct property for renting out.

Ramokolo says listed property offers diversification, as one invests in a portfolio of assets that is well spread out across property, sector and location. “Investors in listed property have the added benefit of investing in assets that are managed by professional property practitioners. They therefore do not need to worry about rental collection and other daily management concerns.”
As a final note however, Ramokolo says “the profile of the investor is clearly the most important ingredient in determining what is best and before deciding, individual investors would need to assess their own needs and limitations, like their investment time period".

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