The sector delivered a strong performance over the quarter, driven by a stable bond market, which in turn was driven by lower global bond yields. Share prices were also buoyed by a healthy reporting season. Trading volumes seem to have returned, in all likelihood due to the fact that future interest rate increases will have a more lagged effect on sector distribution growth, especially since the South African Reserve Bank (SARB) started increasing interest rates by 25bps at a time. We continue to see additional capital raisings in the sector. Redefine (on two occasions), Emira, Nepi, Texton, Vukile and Rockcastle raised capital over the last few months. Potential corporate action remains an overarching theme, with Redefine concluding the most recent strategic acquisition of a stake in a competitor, namely Emira. The rolling 10-year bond yield moved to 8.22% from 8.21% over the quarter. With the relationship between bond and listed property yields remaining strong, accompanied by a small rerating, the sector's clean forward yield moved from 7.7% to 7.5%, with the yield gap opening up by 10bps. This resulted in the sector delivering a total return of 7.2% for the quarter.

The fund marginally underperformed the SA Listed Property Index (SAPY) for the quarter, but continues to outperform the benchmark over one-, three- and five-year periods. The results season was a major driver in price movement during the quarter although liquidity remains a key variable in share price performance, especially for those counters with a concentrated shareholder base. Value-add during the quarter came from the fund's relative exposure to Nepi, Capital, Attacq, Emira and Texton. Relative positioning in Dipula A, Hospitality A, Equites, Capital and Counties, Ascension A and Intu detracted from the fund's performance. The fund reduced exposure to a cross section of stocks (mostly the more liquid stocks) due to cash management. During the quarter, the fund also participated in a few equity placements, including Emira, Redefine and Nepi; increased exposure to Investec Property and Attacq and initiated a position in Tower Property Fund.

Companies representing close to two thirds of the sector's market capitalisation reported during the quarter, with the weighted average distribution growth coming in at an excellent 14.7%. If one excludes the offshore-linked Nepi and Rockcastle, distribution growth equalled 11.3%, which was higher than the 10.0% delivered by the same group of companies six months ago, and the 8.6% produced 12 months prior. Management teams have been doing well overall to achieve this strong growth. From a revenue point of view, overall reversions continue to be positive in most cases, especially within the retail sector. Inroads have been made into vacancies, including the weaker office sector, which immediately comes through as a boost from a like-on-like revenue perspective. Newly signed escalations remain mostly between 8% - 9%, continuously providing a good revenue growth underpin. Funds with a more national retailer bias are achieving escalations between 7% - 8%. Those companies with offshore revenue sources benefited from a weaker currency. Costs have also been well contained, with many of the reporting companies achieving a flat or even lower property operating cost ratio despite the continued pressure from administered pricing. This has in part been achieved through new property management contract agreements or negotiating service contracts on a more national level. A few companies benefited from one-off events such as share buy-backs, fees earned on the unbundling of BEE structures or yield-enhancing property acquisitions. Two divergent strategies are being implemented by companies from a financing point of view. The first strategy is to watch the yield curve closely and hedge when rates are favourable to ensure a relatively smooth hedge expiry profile. The second strategy is to rather keep exposure to variable interest rates at the highest level that shareholders will allow.

Another new listing occurred during the quarter with Delta International completing its reverse listing. Delta International is an Africa-focused property fund, with the local Delta Property Fund being its main shareholder with a stake of 20%. Management intends not to take any development risk and have a pure income focus. It listed on a 7.8% yield with a market cap of around R1bn. The listing assets are located in Morocco and Mozambique. A new CEO, Louis Schnetler, has taken over from Paul Simpson, who will be moving into a strategic consulting role within an executive capacity. Shareholders have benefited from good operational discipline exhibited by management teams in a tough environment through the strong distribution growth delivered in this reporting period. However, distribution growth has probably peaked due to the impact of a weaker rand on many of the numbers. Sector average distribution growth of 7% - 8% is still likely over the next 12 months. The sector is therefore finely balanced while bond yields remain where they are, especially since the relative value to bonds has marginally deteriorated over the quarter due to continued strong distribution growth expectations from the market.

Portfolio manager
Anton de Goede

With bond yields becoming more stable it seems that investors are again looking towards the growth in income from listed property rather than its yield relative to bonds. The sector enjoyed a boost from potential corporate action, with Growthpoint acquiring substantial stakes in Acucap and Sycom. (Growthpoint's intention is to acquire the combined Acucap/Sycom entity once the merger is complete.) This trend of potential corporate action remains an overarching theme in the sector. Besides the Growthpoint transaction, Redefine concluded an agreement to acquire the remaining 35% in Fountainhead it did not already own, while Annuity delisted after being acquired by Redefine as well. Arrowhead, which continues to be very aggressive in its acquisition pipeline, acquired a stake in Dipula (via Dipula B units). The company is also in the process of finalising its acquisition of Vividend. Going against this trend, the potential three-way merger between Rebosis, Delta and Ascension was called off, with Rebosis buying out Delta's stake in Ascension by means of debt rather than properties. The rolling 10-year bond yield moved to 8.21% from 8.32% over the quarter. With the relationship between bond and listed property yields remaining strong, the sector's clean forward yield moved from 7.8% to 7.7%, with the yield gap opening up by only 4bps. This resulted in the sector delivering a total return of 4.4% for the quarter.

The fund marginally underperformed the SA Listed Property Index (SAPY) for the quarter, but continues to outperform the benchmark year to date as well as over the one-, three- and five-year periods. It remains difficult to identify trading trends although liquidity, potential corporate action and results releases are the overall major drivers in price movement. Value-add during the quarter came from the fund's relative exposure to Accelerate, Intu, Fortress A, Hospitality A, Growthpoint and Investec Property. Relative positioning in Capital and Counties (CapCo), Attacq, Ascension A, Acucap, Sycom and Resilient detracted from the fund's performance. The fund reduced exposure to a cross section of stocks (mostly the more liquid stocks) due to cash management. During the quarter the fund participated in a few equity placements, including Equites, CapCo and Fortress; switched a portion of its Acucap holding into Growthpoint; and increased exposure to SA Corporate and Investec Property.

The past quarter saw more new listings in the form of Safari, Equites and Freedom. All three funds are relatively small, with market capitalisations in the vicinity of R1bn. The underlying portfolio of Safari consists of shopping centres, with the bulk of its exposure to the commuter and township markets. In addition, development opportunities exist within the fund, with the most likely development being a shopping centre in Swakopmund. Equites is a specialised industrial fund that consists only of Cape-based properties. Value creation opportunities exist within its development pipeline, especially the option to acquire land at the Cape Town International airport. Management also has realistic expectations with regards to its entry into the Johannesburg and Durban markets. Freedom, in turn, consists of a mixture of commercial, industrial and residential rental and development assets. The initial focus of the fund will not be to be income yielding, but rather to build out its residential and commercial development pipeline. No shares were offered to the public or institutions at the time of listing, with vendors taking up all the scrip. According to SAPOA, office vacancies decreased from 11.1% to 11.0% between December 2013 and March 2014 versus the current cycle low of 7.9%. Vacancies in P-grade space (new office space recently completed) increased from 5.4% to 7.1%. Again the main culprit was an increase in supply in Sandton, with another 22 000m² space being completed (72 000m² the last 6 months), of which only a third is occupied. This points to a trend of increased speculative building activity in premier nodes, especially around the Gautrain stations where the bulk is focused in Sandton (where A-grade space vacancies are vulnerable as tenants move into new premises).

Capital raisings remain a constant in the sector. Although the rights issues of Fortress and Resilient were closely linked with the concurrent capital raising of Rockcastle (so that they can participate), part of it was linked to sizeable acquisitions. Resilient is in the process of acquiring Irene Mall and Jubilee Mall, while Fortress is in the process of acquiring a sizeable Cape-based retail asset. Substantial retail acquisitions like these are becoming less prevalent, with smaller greenfield or existing asset developments more likely. We expect to see continued sizable office transactions, especially those linked to government tenancies, while industrial acquisitions will either be greenfield/turnkey driven or sale and leaseback deals. Other recent capital raisings include CapCo and Redefine.

Companies with a combined market capitalization of close to R90bn have reported during the quarter on their February and March reporting periods. It was good to note that a weighted average distribution growth of 8.2% has been achieved, thereby maintaining the distribution growth momentum we saw in the last two reporting seasons. Although the growth thus far has been partly achieved on the back of some foreign currency earnings growth underpin, a few companies are making inroads in cost management. We have not yet experienced a big impact on actual distributable earnings from the interest rate increase, though all the companies are watching the yield curve closely to opportunistically increase their hedging profiles with the least negative impact on weighted average funding costs.

There continues to be pressure on local macroeconomic fundamentals, which could lead to acceleration in the path of interest rate increases for SA; though the contrary has been occurring thus far. With pressure easing on global bond yields (as monetary policy remain accommodative in major markets), interest rate movements to a more normal level could be back-end loaded rather than imminent. The sector remains vulnerable to the whims of how investors read the path of interest rate increases, while the current rating leaves little room for any distribution growth disappointments, especially after the strong 14.5% return delivered by the sector since the January downturn. Distribution growth prospects, however, remain fairly intact as underlying patchy occupier demand is operationally managed.

Portfolio manager
Anton de Goede

Despite another quarter characterised by volatility and a weak bond market, listed property delivered a total return of 1.0% for the period, supported by an opening up of the yield gap. The main driver was a strong results season, with the average distribution growth delivered coming in at 7.9%. As with the previous quarter, the volatility was linked to global capital market volatility. The eventual announcement in December by the US Federal Reserve to start tapering their quantitative easing (QE) programme put pressure on bond yields, which resulted in the volatility. In response to this, the rolling 10-year bond yield moved from 7.62% to 7.95% through the quarter. Although the relationship between bond and listed property yields remain strong, the sector's clean forward yield only moved from 7.4% to 7.5%, which led to an opening up of the yield gap by 50 basis points, as investors in all likelihood focused on the continued real distribution growth currently being delivered by the sector.

The fund outperformed the SA Listed Property Index (SAPY) for the quarter and remains top quartile over the one-, three- and five-year periods. As was the case in the most recent quarters, it is difficult to pick up any trading trends during the quarter, with the profile of the leaders and laggards all being a rather mixed bag within each grouping. Besides results releases, index inclusions towards quarter-end and potential corporate action seem to have been the main external influences on relative share price performance during the quarter. Strong individual counter relative performance was delivered by Redefine International, Attacq, Investec Australia, Annuity, Nepi, Accelerate and Intu - of which most contributed positively to the fund's relative performance. Some of the fund's larger underweight positions also assisted, especially Growthpoint, Sycom and Fountainhead. A detractor to performance was the fund's relative positioning in Dipula A, Redefine, Resilient, Capital and Hospitality A. Trading activity within the fund includes our participation in the listing of Attacq and Accelerate as well as increased exposure via equity placements to Hyprop, Redefine and Investec Property. We reduced exposure to a broad range of companies, including Growthpoint, Capital & Counties, Acucap, Capital, SA Corporate and Vukile.

Things continue to be very busy within the sector, from new listings, results releases to substantial portfolio acquisitions. The new listings trend within the property space also continues. By December, following the listing of Accelerate Property Fund, the tally of new listings since the listing of Redefine International in September 2010 has reached 16. The sector ended the year with an estimated cumulative R26 billion - R27 billion capital being raised, consisting of vendor placements, cash raisings and new listings. The final quarter of the year saw three new listings.

Attacq listed with a market cap of R8.6 billion and will differ from other locally listed property companies by initially not becoming a REIT, but rather a NAV play with no income initially distributed, but ploughed back into development projects, which includes the Waterfall Estate development in Midrand. In turn, Investec Property Australia is a rand-denominated inward listing, consisting of eight Australian office and industrial properties valued at A$130 million. Accelerate Property Fund, the Fourways focused fund out of the Georgiou stable, listed with a market capitalisation of just over R3 billion. Its major asset is Fourways Mall, which, together with the Georgiou family, is currently in the planning phases of being extended and redeveloped into a super regional shopping centre.

A few observations from the recent results releases follow. Overall vacancies remain under control, with most landlords actually able to fill vacancies, whereby those experiencing an increase in vacancies were node or building specific. Filling of vacancies continue to come at the expense of rental levels, especially in the A grade office space, but it seems as though the 5-year lease expiry profile of leases signed in 2008 is running out; mostly creating a lower base for rental growth.

The retention ratio of tenants is in general 60% - 80%, with those who have a long lease expiry profile, or concentrated portfolio, achieving retention ratios in excess of 90%.

Bad debt provision and write-offs continue to be within acceptable norms, although lower retail trading numbers are putting pressure on some peripheral retail tenants' occupancy cost ratios. Escalation rates are increasingly under pressure, with some leases decreasing by up to 100bps when tenants renew. With retention ratios at these levels, operating cost ratios continue to increase as tenant incentives, especially on the office side, continue to be high. Companies with some type of economic scale benefits have actually improved operating cost ratios. Many companies are putting in infrastructure to improve operating efficiencies, both from an electricity recovery point of view and in order to be more environmentally friendly.

Portfolio growth aspirations continue to be an important feature of the sector, with companies doing placements to have loan-to-value ratios of 20% - 25%. This is to provide sufficient head room to acquire more without coming to the market for every single transaction, especially in an environment where transactions are substantially becoming bigger. Some of the acquisitions announced include the acquisition by Growthpoint of the R6.6 billion Tiber portfolio, Hyprop & Attacq indirectly acquiring Manda Hill shopping centre in Lusaka, Zambia, via African Land and Redefine acquiring 50% in Maponya Mall in Soweto. Bank funding is again reaching competitive levels, making the DMTN market less competitive; especially for the larger companies with good access to bank funding. Many companies that have shortened their debt hedge profile over the last two years and benefited from the lower interest rates have started to enter into forward starting swaps, starting in increments over the next 12 months.

The viability of many of the recently listed property companies will be tested in the next few years as the interest rate cycle starts to turn. Many of the listings came about through the recycling of assets out of the more established listed property companies into a decreasing interest rate market, making initial listing yields attractive on a relative basis versus other interest bearing instruments. Additional growth came about via mostly equity-financed acquisitions. In an environment of rising yields, the attractiveness of these yields, the differentiation of management strategies and ease at which additional equity can be issued (while still meeting investment criteria), will be challenged. Within this environment, sector consolidation aspirations, which form part of the continued portfolio growth aspirations, should become prevalent. Vukile, already taking a strategic stake in Fairvest through accepting equity as payment for asset sales, recently acquired 34% of Synergy, while Arrowhead acquired 31.7% of Vividend.

The performance of the sector remains closely tied to that of the bond market and the further impact of any tapering from the US. Although bond yields seem to have priced in much of the anticipated tapering, risks remain within the local economic environment. This could result in a continued negative stance towards our local bond market, which in turn could impact the local property sector. In addition, the opening up of the yield gap during the month poses the risk that property yields could derate relative to bond yields. However, there has been a call for a disconnect between property and bond yields due to the strong distribution growth prospects (which remain firmly intact between 7% and 8%), which should support the sector in volatile times.