Listed property continued its stellar run of the last few months on the back of much stronger bond yields. As was the case in the second quarter, the sector followed bond yields very closely. After the somewhat surprising 50 basis points repo rate cut in July, bond yields started to price in a potential further cut, buoying the sector. The rolling 10-year bond yield decreasing from 7.46% to 6.86% as a result, supported by strong inflows prior to South Africa's inclusion in the Citigroup World Government Bond Index at quarter-end, which counteracted a ratings downgrade from Moody's in the final week of September. The clean forward yield of the sector moved from 7.4% to 6.9%, with the yield gap remaining fairly constant despite some intra quarter volatility. The sector's market capitalisation is close to reaching another milestone, approaching R200 billion in size. It seems that international investors are increasingly looking towards the sector in anticipation of the introduction of formal REIT legislation within the next six months. The fund outperformed the SA Listed Property Index (SAPY) for the quarter, and remains top quartile over the one- and three year periods. Although much of the sector's momentum remained with the larger and thus more liquid counters, the past results season led to some new names gaining momentum; either on the results itself or improved prospects, which have been driven either by acquisitions or restructurings. However, towards quarter-end the larger more liquid counters bore the brunt of a small sell-off, while the higher yielding smaller listings - which started to gain momentum within results season - continued to attract interest. Positive movers include Investec Property, Hospitality A, Synergy A & B, Hyprop, Vunani and Nepi, whereas Hospitality B, Redefine International, Vukile and Vividend underperformed the broader sector. Most of the fund's outperformance came from our relative positioning in Hospitality A, Vukile, Synergy A & B, Vunani and Redefine, while our exposure to Rebosis, Dipula A, Capital & Counties (CapCo) and Capital Shopping Centres (CSC) detracted. Trading activity within the fund includes increased exposure to SA Corporate, Hyprop and Nepi. We also initiated exposure to Sycom after relative share price underperformance, while we participated in placements of Synergy A, after gaining exposure to Synergy B during the previous quarter, and Arrowhead A and B. We reduced exposure to Growthpoint, Redefine, Vukile and Resilient into strength. The month of August usually provides a good barometer of where we are in the property cycle as 60% of the sector's market capitalisation is involved in reporting. The sector delivered a weighted average distribution growth of 5.9%. Trends captured within the results, which remain fairly similar to what we have experienced earlier this year, include stabilizing and even improving vacancies, while reversions on existing tenants are mostly positive, but focus on total occupancy cost for tenants remain a key driver on how much is tolerable. Landlords, however, need to stomach big rental cuts to convince new tenants to commit in all three sectors. A-grade office vacancies continue to improve, while B-grade vacancies are stabilising, but demand for this space is still weak. There is little scope for further value to be extracted from filling strong retail centres and overall industrial vacancies, while large capital spend is necessary to reposition weaker centres and industrial mini and midi units for tenanting. Operating cost ratios are stabilising and even improving with an increased focus on electricity and water efficiencies. With overall tenant retention ratios improving, less pressure is being placed on operating cost ratios from higher lease commissions and incentives to get space filled, while bad debts and arrears are improving. As usual the property companies continue to recycle capital into new assets. What is evident is the increased appetite for speculative developments, some of it through land banking, while existing projects in the ground are mostly industrial (logistic and distribution linked within park-like environments) and office (in vicinity of Gautrain stations) driven. Funding margins are favourable for development projects that are part equity part capital market funded, and it seems that a margin of at least 150 - 200bps on development yields versus funding costs are achievable. The capital investment of some of the more recent listings within the sector continues (rural, township and commuter retail remain firmly on the radar screen, with yields being paid moving into the 8% levels), which is also going hand in hand with equity issuances. Larger funds are using the opportunity to clean up their portfolios, leading to some churn within the sector. Africa ex- South Africa is coming more into play with many companies looking to gain a foothold into the continent in some way or another. Both CapCo and CSC released interim results during the quarter. CapCo continued on its path of creating value from Covent Garden with estimated rental growth (ERV) growth and signing new brands at higher than passing rents. Management continues to unlock capital by selling down the assets in the Great Capital Partnership. Conditional planning approval for Earls Court has been achieved in September from the Hammersmith & Fulham council, with approval from Kensington & Chelsea expected before year-end. The next leg in value creation is about to start with the Seagrave Road development at Earls Court in the first quarter of 2013. CSC in turn had to bear the brunt of the weak retail environment in the UK ex- London with 2% of retailers going into administration, leading to - 2.3% like-on-like net rental income growth. Despite the weak operational performance, the portfolio value did not move backwards. Additional portfolio value will be created through plans currently being submitted for planning approval for most of its centres. The IPD released the results of their South Africa Property Bi-Annual Indicator - the six-monthly return of SA direct property. After delivering a total return of 13.3% for 2010 and 10.4% for 2011, All Property gathered momentum, delivering a total return of 5.9% for the first half of the year versus 4.3% for the comparative period in 2011; 4.6% for the comparative period in 2010, and 3.4% for the comparative period in 2009. A recovery in capital return was the main driver behind the improvement between 2011 and 2012, while stronger rental growth assisted the income yield on industrial properties. The Bi-Annual Indicator is pointing to the gradual return of positive momentum within the direct property market. From the recent results season similar signs have been coming through of a potential upturn in fundamentals. We believe this should start to reflect in positive distribution growth momentum in the next 12 to 18 months, especially since funding costs are being fixed at historically low levels. Listed property, albeit looking expensive on an absolute basis, is becoming more attractive relative to bonds based on this improved growth profile. However, the fortunes of the sector continue to be very closely tied with that of the bond market, and therefore implicitly to the potential of another rating downgrade in the coming months due to the building of negative domestic macroeconomic pressure. A wild card remains the potential of another rate cut as the SA Reserve Bank continues to focus on domestic growth rather than on inflationary risks linked to the weaker rand.
Portfolio manager
Anton de Goede

Listed property followed bond yields very closely this quarter. Despite the weaker rand, South African bonds gained over the past three months, largely taking lead from the downward trend in US bond yields. The rolling 10-year bond yield decreased by 55 basis points over the period. In addition the potential of an interest rate cut is being priced into the shorter end of the yield curve. Inflation expectations seem to be less bearish than earlier this year, while dovish statements by the South African Reserve Bank point to likely interest rate intervention should economic and financial market signals out of Europe deteriorate further. This has led to stronger trading volumes towards the end of the quarter, with momentum again closing in on that of the first quarter of 2012, which was very strong. Another likely boost for the sector was a renewed focus on potential corporate action as both Redefine and Capital announced the potential acquisition of Fountainhead and SA Corporate respectively. We may see some potential bid premiums being priced into other stocks which the market may view as potential take-over targets. All of these supported the sector to delivering a total return of 10.3% for the quarter. The sector continues to outperform both equities and bonds year to date, delivering 2.7x and 2.5x the total return produced by equities and bonds respectively. The fund outperformed the SA Listed Property Index (SAPY) for the quarter, and remains top quartile over the longer one- and three-year periods. Most of the positive relative share price movements were results driven. In addition some of the more established counters in the sector benefitted from already high ratings and higher liquidity. It appears that those investors, who want to increase their exposure to the sector to benefit from a potential interest rate cut, have stuck to buying the more established names within the sector. Positive movers include Investec Property, Hospitality A, Vukile, Dipula A, Growthpoint and Rebosis, whereas Hospitality B, Redefine International, Arrowhead, Sycom and Synergy moved in a negative direction. Most of the fund's outperformance came from our relative positioning in Dipula A, Hospitality A, Rebosis, SA Corporate, Sycom and Capital & Counties (CapCo), while our exposure to Fortress A, Vunani and Capital Shopping Centres (CSC) detracted from performance. Trading activity within the fund includes increased exposure to Nepi, Hyprop, Rebosis and Vukile. We also initiated exposure, once again, to SA Corporate and Octodec after relative share price underperformance, while acquiring Synergy B for the first time since listing in December 2011. We reduced exposure to Resilient and Redefine into strength. Some interesting trends are emerging from the sector: ?? We may be moving to a definitive two-tier market. At the one end, the larger more established companies are out to grow their portfolios by not only acquiring third party portfolios, but also from within the sector. Come end-2012, we may find a market comprising of five listings with market caps above R10 billion (including three above R20 billion) and 18 listings with market caps below R6 billion, of which the bulk may be below R3 billion. With Redefine and Capital on the lookout we may even see some of the smaller listings being targeted by larger funds. ?? The two biggest factors impacting on positive distribution growth are the filling of vacancies and the containment of operating costs - although there is a large focus on reversionary rentals, the impact thereof is relatively small. ?? The positive contribution that any yield enhancing acquisition/development will bring to underlying distributable earnings cannot be underestimated in an otherwise challenging operating environment. ?? Companies are riding the yield curve wave by increasing their funding exposure to the capital markets and benefitting from the short-term dated low interest rates. Two new property companies that listed during the quarter include Annuity which listed in May and Ascension which listed in June with an A & B unit structure. Given the flood of listings experienced in 2011, it is becoming more challenging to list. As a result, Annuity and Ascension had to put in place clever debt structuring or yield sweeteners to whet the appetite of investors. Hermans & Roman however became the first property listing not successful in raising sufficient capital after publicly announcing its intention to list. The company continues to struggle to raise capital and the likelihood of a listing is becoming smaller. It was encouraging to see some of the more recent listings actually delivering on the forecasts as set out in their pre-listing statements. Investec delivered a positive surprise as clever additional acquisitions and well structured financing agreements supported much better distribution levels by the fund than anticipated. Arrowhead, Rebosis and Dipula seem on track to deliver the full-year distributions as per the guidance provided to at the time of listing. Some of the smaller, more recent listings also announced acquisitions of which a number remain to be the recycling of existing property assets in the sector. Recent deals, however, point to some shift towards new assets being added to the sector. Prime and A-grade office properties and township retail are clearly experiencing the start of a compression in yield, with only the current debt funding rates making acquisitions of these properties yield enhancing. In addition, some of the more recent listings with BEE credentials are positioning themselves to benefit from Government leases, and potential longer renewals by acquiring Government tenanted properties mostly located in the CBDs of South Africa's major cities. Both CapCo and CSC released interim management statements during the quarter. CSC is operating within a challenging retail environment with tenants in administration increasing as the woes in the UK retail market continue. What is different from the first quarter of 2009, when we last experienced so many retailers going into administration, is that the company is taking a much firmer stance on rental levels rather than just occupying the space with short-term lets. This was successfully implemented in 2009 by the current COO which was then heading up Trafford Centre, and should provide long term NAV protection for CSC. In turn CapCo continues to benefit from the strength of Central London retail, capital recycling initiatives as well as the political will to get the Earls Court redevelopment off the ground. With the sector running so hard year to date it remains difficult to predict what will happen for the rest of the year. The strong correlation with bond yields this past quarter points to how the fortunes of the sector will in all likelihood be very closely tied with that of the bond market for the rest of the year. This would imply that the momentum of the last six months is probably slowing down, but will remain positive as the underlying direct market starts supporting distribution growth prospects as the strong performance of commuter retail and logistic warehousing come through.

Portfolio manager
Anton de Goede

Strong momentum led the listed property sector higher in the first quarter of 2012, very similar to what happened towards the end of last year. The sector was also supported by a combination of lower bond yields on the back of a stronger rand and some blanket buying that might have taken place to gain exposure to the sector. The indications are that Eskom might have driven this blanket buying to regain some exposure to commercial property through the listed sector having sold its stake in Pareto to the PIC towards the end of 2011. After recording the third highest monthly value traded in February, trading values reached record levels in March, outperforming the previous record level by approximately R1 billion, or close to 20%. These levels of trade pushed the sector to delivering a total return of 8.0% for the quarter.

The fund marginally underperformed the SA Listed Property Index (SAPY) for the three-month period, but remains top quartile over the longer three-year period. Relative share price movement remained erratic, with some of the smaller illiquid counters (which previously lagged the sector) coming through slightly stronger. It however remains very difficult to recognise any trading patterns within the sector. In addition, share prices were heavily impacted by the results released during the period, with some investors remaining prepared to pay up for defensive, more predictable revenue streams. Positive movers include Arrowhead, Resilient, Vunani, Nepi, Growthpoint, Fortress and Hyprop, whereas Hospitality, SA Corporate, Vividend, Premium and Synergy moved in a negative direction. Most of the fund's underperformance came from our relative positioning in Growthpoint, Hyprop, Hospitality A, Rebosis and Dipula A, while our exposure to the non-benchmark constituents Capital Shopping Centres (CSC) and Capital & Counties (CapCo) also detracted from performance. Hospitality Property Fund recently received some negative media coverage in light of a likely rights issue and debt refinancing difficulties. We remain comfortable with our position in Hospitality A as we believe the structure of the fund into A and B units is beneficial for the holders of A-units. In addition, the current yield in excess of 10% does not reflect the long-term certainty of the income growth for A units, especially in the current improving hotel operating environment. Positive relative performance contributions came from our relative positioning in Vunani, Resilient, SA Corporate, Sycom and Premium. Trading activity within the fund includes increasing our exposure to Capital, Hyprop, Rebosis and Vuikle. We also continued to reduce the fund's exposure to Acucap, Growthpoint and Investec into strength, as well as Redefine due to lack of conviction in management's current strategy.

The budget speech confirmed the alignment of the tax treatment of the property loan stock (PLS) sector with that of the property unit trust (PUT) sector with the introduction of real estate investment trust (REIT) legislation as early as 2013. This process already started back in 2007. We believe that this will have a positive impact as the sector will then be directly comparable to other international markets with REIT legislation. The PLSA indicated that at present the likelihood of a conversion charge to the new structure will be small, thereby resulting in the current deferred capital gains tax liabilities not realised and thus pushing NAV levels higher.

The take-out from the results announcements include signs of some improvement in the retail sector as well as industrial properties associated with distribution and logistics; offices, especially B-grade offices, continue to struggle; tenant retention ratios continue to decrease as many landlords compete to lease space to the few tenants that are currently looking for premises; escalation rates remain in the 8% - 9% range except for large national anchor tenants where this can be as low as 7% and the trend of operating cost growth exceeding rental income growth continues. Furthermore funding costs continue to decrease with the lower interest rate environment being used to enter into interest rate swaps and even forward starting swaps at levels below 9%. To diversify away from a dependency on traditional bank funding more funding avenues within the capital market are being sought. The results announcements also indicated that the move into so-called quality properties continues, where smaller, multi tenanted properties are disposed of in favour of larger single tenanted properties. At the moment, this move is mostly yield dilutionary as it seems some price chasing is taking place with most of the smaller properties being sold returning to the listed space through some of the smaller listings. Most of these acquisitions seem to be taking place in the office sector, while the transactions seem to be taking place with some kind of related party, or between parties where a strong established relationship exists.

Some reflection after the results season points to a number of interesting trends. Although the sector delivered a weighted average distribution growth of 7.5%, the resulting full year distribution growth of 5.7% for 2011 was the lowest since the 4.2% delivered in 2004, which reflects the challenging underlying operational environment. Pressure on top-line growth remains, with operating cost pressure making it difficult to increase rentals as tenants consider total occupancy costs. Higher tenant retention ratios have come through this reporting season, which is promising, but definitely at the expense of rentals. Tenants continue to rather negotiate on rentals than the escalation rate, which on average is staying in the 8% - 9% range. Shorter leases are still being signed. B grade offices and smaller industrial mini and midi units are taking the most strain at the moment as are a few retail centres where its position in the market is weak.

An increase in defensive capex, and on a larger scale, is being noticed to ensure that properties remain competitive in a challenging market. With A grade offices and industrial properties performing the best on a relative basis, some speculative office and industrial developments are being initiated by landlords. However, despite comments relating to construction margins being favourable, development yields are decreasing. One of the biggest trends of the current cycle continues, namely the clean-up of portfolios through the selling of smaller, higher yielding properties, while consolidation potential still exists. The latter was illustrated by the announcement of Redefine's potential acquisition of the Fountainhead management company and potential subsequent offer for all its properties. In addition, smaller new listings into the sector continue to take place with Ardor and Annuity being the first of the next prospective wave to follow the 6 new listings in 2011. The viability of some of these listings remains in question as many assets going into them are being recycled from existing listed property companies.

Although inflationary risks remain within the system, local bond yields continue to trade more in line with global bond markets, which remain at low yields. Despite operational challenges remaining within the local property market, some bright spots are emerging, which point to a potential distribution recovery in 2013. This is where the importance of management teams and their experience in operating through past property and interest rate cycles come into play for individual stock selection. These two factors will support current share price levels in the short to medium term, making tactical asset allocation decisions difficult. We see the momentum of the last few months to continue, but at a slower pace.

Portfolio manager
Anton de Goede

The listed property sector benefited from a combination of lower bond yields and a stronger equity market during the past quarter, resulting in a total return of 3.7%. For the year as a whole, the sector delivered a total return of 8.9% versus 2.6% from local equities and 8.8% from local bonds. During this 12-month period strong performances came from companies where management teams realistically guided the market in terms of distribution growth and did not disappoint on the guidance provided. Secondly, within a challenging operating environment those companies where certainty of income stream and growth were more secure (either due to sector exposure or operating excellence) also performed strongly. Thirdly, some companies rerated strongly relative to the sector due to improved ratings.

After two months of performing in line with the SA Listed Property Index, lower than benchmark performance in December has led to the fund underperforming for the quarter. It however remains in the top quartile over the 12- and 36-month period. Trading patterns remained erratic, where trading levels were impacted by very small trades or a very wide bid-offer spread. This was especially noticeable in those companies where concentrated shareholder bases exist. The best performers were those companies that maintained positive momentum from the previous quarter as well as those with positive results announcements. Positive movers within this category include Sycom, Investec, Fountainhead, Resilient, SA Corporate, Vukile and Growthpoint, whereas Hospitality, Redefine, Hyprop and Emira stood on the opposite end. Most of the fund's underperformance during the quarter came from our zero exposure to Sycom and SA Corporate, while our exposure to Capital Shopping Centres (CSC), a non-benchmark constituent, also detracted from performance. CSC released an interim management statement and although the UK retail environment remains tough we still believe that the longterm potential in the company overrides the short-term risks. Positive relative performance contributions came from our positions in Capital & Counties, Resilient and Hyprop. Trading activity includes the completion of the sale of the entire Foord holding. We continued reducing the fund's exposure to Acucap into strength, as well as Redefine due to lack of conviction in management's current strategy. Some of the cash raised was used to increase the fund's exposure to Growthpoint in favour of Capital due to its defensive nature. In addition we started to increase our exposure to Emira into weakness based on yield relative fundamentals and continued with our Vukile and Rebosis buying. We also participated in a placement of Hyprop shares which were placed as part of the Attfund transaction.

November saw an increase in the number of property companies that report due to the new listings that took place in 2011. With all of these new listings (Investec, Rebosis, Vividend, Dipula and Vunani) still in their maiden year, most of the trends which were picked up upon within the sector came from the established listings which reported. The weighted average distribution growth delivered by the main five of seven which reported was 3.7%, although this was heavily influenced by Redefine, which pulled the average down.

The take-out from the results announcements include signs of some improvement in the retail sector as well as those industrial properties associated with distribution and logistics; offices, especially B-grade offices, continue to struggle; tenant retention ratios continue to decrease as many landlords compete to lease space to the few tenants currently looking for premises; escalation rates remain in the 8% - 9% range except for large national anchor tenants where this can be as low as 7% and the trend of operating cost growth exceeding rental income growth continues. Furthermore funding costs continue to decrease with the lower interest rate environment being used to enter into interest rate swaps and even forward starting swaps at levels below 9%. To diversify away from a dependency on traditional bank funding more funding avenues within the capital market are being sought. The results announcements also indicated that the move into so called quality properties continues, where smaller, multi tenanted properties are disposed of in favour of larger single tenanted properties. This move is mostly yield dilutionary at the moment as it seems some price chasing is taking place with most of the smaller properties being sold returning to the listed space through some of the smaller listings. Most of these acquisitions seem to be taking place in the office sector, while the transactions seem to be taking place with some kind of related party, or between parties where a strong established relationship exists.

December turned out to be a rather busy month for the sector with two new listings. Arrowhead unbundled from Redefine into an A & B unit structure more reminiscent of that which was used with the now delisted ApexHi, while Synergy also listed with an A & B unit structure. Both have relatively small market capitalisations, with Arrowhead at a combined R831 million and Synergy at a combined R598 million. Both intend to bulk up their portfolios in the immediate future, mostly funded with additional equity issuances. Synergy already indicated prior to listing that additional A units are to be issued in the first quarter of 2012 to fund acquisitions in the pipeline. With the tendency to use an A & B structure recently increasing, the appropriateness of using such a structure, in whatever form, needs to be scrutinized carefully. The merit of the structure has been clearly illustrated by the recent trading patterns of Hospitality. Given the current slump within the hospitality industry, the company announced its prospects of negative revenue growth for the coming reporting period. Although the protection being provided by the revenue allocation to the B units have eroded substantially over the past two years due to the state of the hospitality industry, the A unit should still receive its lower than 5% or CPI distribution growth.

Two opposing trading patterns seem to remain within the sector. With inflation concerns still firmly in the market and for the first time more pertinently mentioned by the Monetary Policy Committee, many investors who were in the sector for a potential rerating exited as the likelihood of a rate cut has probably lost momentum. The reality of a challenging operating environment finally seems to be filtering through to non-specialist property investors. In turn, yield seeking investors continue to support the sector with emphasis being placed on the certainty of income stream in times of equity market volatility and European debt concerns. In addition, an improvement in retail and industrial renewal rates with the November reported results compared to those reported in August may have prompted some renewed interest in the sector. Vacancies remain key, and as long as landlords can manage to keep it down, a 4% to 7% sector distribution growth for the next 12 months could still be possible. Current bond yields should continue to support the sector in the short term, with inflationary risks in the medium to long term potentially impacting the sector negatively.

Portfolio manager
Anton de Goede