The listed property sector continued its defensive ways, with a third quarter 2009 total return of 12.2%, which outperformed a total return of 5.5% from bonds, but slightly underperformed equities (13%). Year to date the sector has underperformed equities with a total return of 9.7% versus an equity total return of 18.3%. Over this period the sector did, however, outperform bonds, which returned a negative 1.6%.

66% of the property companies by market cap reported their results during the quarter. Most companies reported distribution (dividend) growth in line with our expectations. However, growth in distributions has slowed to upper single-digit levels compared to the double-digit growth seen in 2008. A clear trend in the results was the increase in vacancies, which was expected. In most companies, vacancies were still below 5%, and therefore not a material concern at this stage. But we have seen a marked reduction in rental growth on expiring leases, especially in the retail sector where it was around 10% last year, and has now dropped to below 5%. Hardest hit were companies with large exposures to community shopping centres (Emira and SA corporate property funds), and it is clearly evident that small tenants in those centres are taking strain. Larger shopping centres are still trading well, with no noticeable signs of concern at this stage.

In our view the listed property sector is fairly valued and offers defensive cash flows, albeit with lower growth over the next two years (7%-8%) than in the previous two (12%-14%).

The listed property sector has been range bound so far this year, recording an unexciting negative 3% total return to June, outperforming the All Bond Index's (ALBI) negative 6%, but underperforming the FTSE/JSE All Share Index's (ALSI) 6%, as "bombed out" equities staged some recovery. The sector's performance relative to equities will be largely determined by investors' appetite for risk. Property is, however, more likely to outperform cash and bonds as the sector's forward income yield of 10% is some 2% above that of cash, and still offers income growth. The listed property sector is fairly valued and offers defensive cash flows, albeit with lower growth over the next two years (7%-8%) than in the previous two years (12%-14%). Market rentals have largely peaked and tenant arrears have increased. Property expenses (especially higher electricity, rates and taxes) are putting pressure on tenants' ability to afford space and landlords' operating margins. While vacancies are expected to rise over the next two years, the slowdown in building completions means that national vacancies are unlikely to rise to the crisis levels of above 12% recorded in 2002, and may top out at 6%-7%. Expiring leases are still below market rentals and continue to provide an uplift to revenue growth. Overall the fund is well positioned at present as most of the major restructuring happened last year. The fund should benefit from the expected re-rating of Redefine, should it be included in major global and local indices.

The listed property sector recorded a -1.4% total return in the first quarter of 2009, boosted by a 2.6% gain in March along with the FTSE/JSE All Share Index, which climbed 11% in the month. Listed property regained some lost ground relative to bonds, which were down 5.1% in the first quarter after a substantial rally in the second half of last year.

Market rentals have largely peaked and tenant arrears have increased. Property expenses (especially higher electricity, rates and taxes) are putting pressure on tenants' ability to afford space and landlords' operating margins. Funding has become tougher and companies have shelved all except alreadycommitted capital expenditure, which will serve to curb the amount of new supply.

Vacancies are expected to rise over the next two years, from 3%-4% to 6%-7% and, while this will limit rental growth, most existing contractual rentals are below market levels and will continue to increase on expiry. The bulk (around 80%) of a property company's revenue is contractually rising at 8%-9%, which will significantly underpin growth.

The sector's performance relative to many bombed-out equities in an uncertain economic environment is unknown, although property has a far higher degree of stable cash flow. Listed property provides an income yield which is higher than cash yields, which will fall as the Monetary Policy Committee (MPC) continues to cut interest rates. Listed property is fairly valued and could provide 15% return over the next 12 months.

The fund increased its total exposure to Redefine and reduced its exposure to mid-sized Acucap and Emira over the period.

2009 was a historic and volatile year for the market and listed property. The listed property sector returned 8.5% in the fourth quarter but -4.5% for the year, significantly outperforming the FTSE/JSE All Share Index's -9.2% and -23.2% respectively. It also proved more resilient over the year than other interest rate sensitive sectors: banks -10.3% and general retailers -15.7%. Although the sector staged a recovery in the last quarter it still underperformed bonds, which started to price in significantly lower inflation and interest rates. This was confirmed in December when the Monetary Policy Committee (MPC) cut interest rates by 0.5%. OMIGSA's Economic Research Unit expects the MPC to cut interest rates by at least another two percentage points in 2009. Lower lending rates (despite an increase in bank lending margins) will not only see lower interest expenses, it will also make committed capital expenditure less dilutionary and start to provide a platform for a slow recovery in the retail sector. Sector distribution growth has, up until the last round of financial reporting in June and September, remained surprising robust at around 12.5% year on year. The growth rate is, however, forecast to decline to 9% -10% over the next two years - notably continued positive real growth. Assuming that bond yields remain relatively unchanged this year, listed property could produce around 20% before tax, and as much as 30% should it re-rate relative to bonds. The fund sold a wide range of shares in December to increase its cash holding in order to take advantage of potential opportunities. It reduced its exposure to Resilient and increased its holding in ApexHi. The fund is not overweight to ApexHi, having come from a near-zero holding over a year ago.