Listed property returned 13.7% in the third quarter of 2010, taking the yearto- date total return to 25.7%. The quarter's return was above the 8% returned by the All Bond Index (ALBI) and the 13.3% delivered by the FTSE/JSE All Share Index (ALSI), but below general retailers, which returned 24.7%. The capital gain is solely attributable to the continuation of the bond rally. Property could have done better as listed property yields fell by less than bond yields over the quarter, despite in-line third quarter financial results. Lower yields result in higher prices.

Listed property has scope to appreciate in its own right. The de-rating relative to bonds is despite low cash rates and benign inflation, which make property particularly attractive. Operating conditions are stabilising even if they remain difficult. Capital values are vulnerable to a bond sell-off. Property offers improved value relative to bonds. The forward yield is 2% above cash (at around five-year highs) and just above bond yields. It should outperform domestic equities in a down market, but will not be immune to a bear market.

After 10% growth in the first quarter of 2010, listed property provided just a 0.6% total return over the second quarter. By contrast, the FTSE/JSE All Share Index (ALSI) fell 8.2% while bonds returned 1.1%, and the general retail sector (4.1%) fared much better.

The 24 basis point (bp) increase in bond yields was detrimental (as this lowers capital values) and listed properties' yield spread to bonds ended the quarter little changed. The quarter's results were generally reasonable but unfavourable earnings guidance was below expectations. Many funds believe they are "bumping along the bottom".

Compared to bonds, property offers a similar yield to what it did at the beginning of the year, although there is less value than there was 12 months ago. It provides a forward yield of more than 2.5% higher than the money market (at around five-year highs), with medium term, above-inflation dividend growth still expected. Relative to domestic equities, it should outperform in a down market but will not be immune to a downturn.

Domestic listed property had a notably strong quarter, returning 9.9% (6.6% capital appreciation), in line with the general retailers (9.6%), even though property has less operating leverage. This was double the return of the FTSE/JSE All Share (ALSI) (4.5%) and All Bond (ALBI) (4.4%) Indices. We attribute this to four factors - bond yields, results, economic growth prospects and property fundamentals. Bond yields declined 46 basis points (bps) (property yields fell only 34bps). Results as a whole did not disappoint and reported prospects were reassuring to the market. The consensus outlook for economic prospects has improved. Letting interest has picked up and many funds believe vacancy rates will peak this year, and that cap rates have topped. Compared to bonds, property offers less relative value than a year ago with improved sentiment. Relative to domestic equities, it should outperform in a down market but the extent of the recent relative strength in an up market is surprising. The sector provides a fair, but not cheap, one-year entry yield (8.9%) and can sustain a positive real distribution growth, albeit at a slower rate. Downside operational risk has declined. A genuine recovery in property conditions may take longer than many anticipate, with vacancies increasing in some markets; higher electricity and rate costs constraining net rental growth; new space continuing to come to market, and over-rentals possibly developing in time (a key concern). The growing economic optimism and the rate cut are positive. On a long term secular view, property is attractive as existing rents are below viability rentals for new developments.

According to FTSE/JSE figures, South African listed property provided a 14.1% total return in 2009 (4% in the fourth quarter), of which 4% was capital appreciation. This is a robust performance considering the rise in bond yields (which depresses property prices) and a falling distribution growth rate.

The yield on the generic 10-year government bond rose 176 basis points (bps) in 2009 (22bps in the fourth quarter) with the All Bond Index (ALBI) delivering a -1% return (+1% in the fourth quarter), with a 10% capital loss. Compared to bonds, property now offers substantially less relative value than it did at the beginning of 2009.

The growth rate of listed property distributions in 2009 fell to 7.4% from 11.6% in 2008. This was a sharper deceleration than the market anticipated. Direct property conditions became tougher with higher vacancy rates (on par with our expectations), a struggle to let new developments and softness in market net rentals.

General equities outperformed with the FTSE/JSE All Share Index (ALSI) delivering a 32.1% total return (11.4% in the fourth quarter). This could favour property in the event of a pullback in equities.

The sector is appropriately valued and can sustain positive nominal distribution growth, albeit at a slower rate over the intermediate term. Direct property market newsflow may become more negative (e.g. office vacancy rates are heading for double digits in some markets), higher electricity costs constrain net rental growth and significant new space continues to be released. The optimism implicit in the strength in retailers' share prices is positive for listed property. On a long term secular view, property remains attractive as existing rents are too far below viability rentals for new developments.