After three consecutive negative quarters, listed property returns turned strongly positive and SA listed property rose by 23%. Holdings in the fund that outperformed during the quarter were Hospitality B (+40%), Sycom (+38%) and Hyprop (+31%), while SA Corporate (+1%), Libint (+5%) and Pangbourne (+15%) performed worst. SA bonds also had a good quarter (+13%) as debt investors perceived the top in the current rise in inflation.

This contrasted vividly with the -21% return in SA equities as the international financial and economic backdrop deteriorated further. Resource shares were particularly hard hit.

Three months ago we cited rising bond yields and less favourable pricing of risk as negative factors for listed property. No sooner had we noted that, than the 10-year bond yield fell by 2%, allowing listed property yields to fall too.

The end-June reporting season confirmed that growth fundamentals remain positive for SA property. Space supply is constrained by high funding and building costs, while demand maintains some momentum. At the same time, more negatives are coming into focus as the property cycle turns. Bad debts from tenants are rising and are likely to convert into vacancies as the cycle turns further.

At the time of writing, listed property yields are at parity with the 10-year SA government bond yield. This may indicate that the market is not expecting rentals to grow at all into the future. Given that the current annual growth rate is above 10% and we have not had negative revisions to forecasts yet, this rating may be prematurely signalling the end of the rental growth cycle. We expect listed property to continue to provide a growing income.

Listed property returns continued to be negative over the quarter. Liberty International fell by 13% and SA listed property by 20%. Holdings in the fund that underperformed during the quarter were Sycom ( 23%), Hyprop (-22%) and Fountainhead (-21%), while Libint, Hospitality A (-16%) and Vukile (-16%) performed best.

News from major foreign property markets continues to deteriorate, as credit is being rationed and there is a risk of recession in the US and UK. In SA, rising energy and food prices have contributed to higher than expected inflation, to which the monetary authorities have responded by increasing interest rates. In turn, listed property yields have risen, giving rise to capital losses.

Having affected capital values, the next big question is to what extent higher interest rates will affect income from the occupational market. In particular, will property occupancies remain high, and will reversions (when contractual leases are marked to market on expiry) remain positive? Some negatives are coming more into focus as the cycle turns. Bad debts from tenants are rising and are likely to convert into vacancies as the cycle turns further.

Nevertheless, listed property fund managers report that growth fundamentals remain positive for SA property. Space supply is constrained by high funding and building costs, while demand maintains some momentum. The market is expecting income growth of above 10% per annum for the next two years. Interest rate fluctuations will not disrupt this much as most debt in the underlying funds is at fixed rates over this period.

Listed property is likely to continue to provide a growing income, but we have moderated our expectations for total returns as the underlying property cycle shows signs of turning, risk is priced less favourably and bond yields have risen.

Sanlam Property Fund changed its name to SIM Property Fund on 1 August 2008

Listed property returns were negative over the quarter. Positive returns from Liberty International (+5%) were insufficient to offset negative returns from loan stocks (-10%) and property unit trusts (-13%). Holdings in the fund that underperformed during the quarter were SA Corporate (-20%), Resilient ( 20%) and Emira (-15%), while Libint, Hospitality A (+4%) and ApexHi C (-4%) performed best.

We noted in our previous report that there was negative news from major foreign property markets, where, in the US and UK, credit is being rationed and there is risk of recession. The SA market belatedly joined the rest of the world in experiencing falling listed commercial property prices as credit tightening caused risk to be repriced globally. The same forces of risk aversion also led to selling of the rand. In turn, Libint came to the fore as an excellent diversifier of SA property returns as rand weakness more than offset its price decline in sterling.

Growth fundamentals remain positive for SA property. The market is expecting income growth of above 10% per annum for the next two years. Interest rate fluctuations will not disrupt this much as most debt in the underlying funds is at fixed rates over this period. However, some negatives are coming more into focus as the cycle turns. Bad debts from tenants are rising and are likely to convert into vacancies as the cycle turns further. Erratic electricity supply could accelerate this process. (On the other hand, no electricity is available to new developments, which will limit property supply and strengthen the position of existing landlords).

The capital outlook has become less certain. Direct property yields are set to rise after falling for several years since 2001. Property is priced off bond yields, and we have shifted the band that we are anticipating for the 10-year bond yield from 7-9% to 8.5-10.5% to account for deteriorating economic fundamentals, inflation in particular. This has reduced the expected return from listed property - we now expect returns similar to those from cash, but at more risk.
Listed property is likely to continue to provide a growing income, but we have moderated our expectations for total returns as the underlying property cycle shows signs of turning, risk is priced less favourably and bond yields have risen.

Listed property returns were flat over the quarter. Positive returns from property unit trusts (+3%) offset negative returns from loan stocks (-1%) and Liberty International (-7%). Holdings in the fund that outperformed during the quarter were Sycom (+12%), Acucap (+6%) and Resilient (+5%), while Vukile (-9%), Hospitality A (-8%) and Libint underperformed.

Both Sycom and Resilient are potential participants in further property fund consolidation, while Vukile deferred announcing the terms of an acquisition. Libint detracted from the quarterly and annual performance, but it serves as an excellent diversifier of SA property returns.

The muted quarterly performance resulted from the netting out of positive domestic fundamentals and negative news from major foreign property markets, where, in the US and UK, credit is being rationed and there is a risk of recession.

As a whole 2007 was another excellent year for property returns (+27% on SA listeds and +18% on the Capped Property Index, which we use as our benchmark). Listed property has built up a formidable performance record, best reflected in the 5-year compound total return of 41% p.a. of the loan stocks.

Growth fundamentals remain positive for SA property. The market is expecting income growth of above 10% per annum for the next three years. Interest rate fluctuations will not disrupt this much as most debt in the underlying funds is at fixed rates over this period.

The capital outlook is less certain, as always. Property is priced off bond yields, and the 10-year bond yield is consolidating close to the middle of the 7-9% yield band that we are anticipating.

Property continues to be more highly rated than bonds, and at year end the yield gap was above -2%, confirming that fundamentals are cyclically robust.