Market review

The SA listed property index (SAPY) returned a total of 10.1% in Q1'16, rebounding sharply post the indiscriminate sell-off in early December after our Minister of Finance was fired. This was driven by a mix of long-bond yields rebounding from depressed levels and strong results from the underlying property counters. It was the best performing domestic asset class in Q1'16, outperforming local bonds (up 6.6%), general equities (up 4%) and SA cash (1.7%).

On a trailing 12-month basis, listed property returned 4.6%, underperforming SA cash (6.6%), but outperforming SA general equities (3.2%) and SA bonds (-0.6%). The SA repo rate increased by a cumulative 75bps in Q1'16, which will have a twofold impact: it makes cash more attractive as an asset class in absolute return terms and in time it will raise the cost of debt for SA listed property as hedges mature.

The best performing shares in the SAPY for the quarter were Redefine (23%), Resilient (19%) and Hyprop (16%), as these happened to be some of the harder-hit and hence depressed shares post the December sell-off. Likewise, some of the worst performing SAPY shares in Q1'16 included rand hedges like Stenprop and MAS plc. This was due to their 100% foreign currency exposure, as the rand strengthened following its indiscriminate December sell-off and fears of Britain exiting the EU adversely impacted sentiment around shares with UK exposure, including ITU and CCO.

What SIM did
Before fees, the SIM property fund returned 9.4% for the quarter, and 4.9% on a trailing 12-month basis. This represents a slight underperformance for the quarter and small outperformance over the past year against the SAPY benchmark.

We took profits on Redefine and Growthpoint following the strong performance of SA based property, especially relative to counters with predominantly offshore exposures, such as Rockcastle, MAS plc, Stenprop, Intu and CCO, which underperformed materially due to rand strength and fears of Britain exiting the European Union (referred to as 'Brexit') in the case of those with UK exposure.

So, as the rand strengthened and these shares got knocked down in their local UK listings on Brexit fears, we gradually added to Intu and CCO, which we consider better quality than MAS and Stenprop. These shares fell as much as 25% in their UK listing, and we have so far accumulated 1% of the fund in ITU/CCO combined, effectively upping the offshore weighting of the fund. Intu is the owner of some of the UK and Spain's largest shopping centres, and trades on a 4.7% sterling yield and a more than 20% discount to net asset value (NAV). CCO is a developer in the UK, owning prime retail and residential properties and land in London, and trades at a 10% discount to NAV.

The SAPY index has about 38% effective offshore exposure. The SIM property fund has now increased its effective offshore exposures to around 32% following the above purchases. So overall, we are still favouring rand-denominated counters over offshore as we are still of the view that the rand is cheap. Finally, we have introduced a small (under 3% and gradually increasing) cash position in the fund as the sector continued to rally towards what we believe is now no longer cheap price levels. This is to provide some protection against a reversal of some of the strong absolute gains experienced over the past quarter, as well as option value in the sense that the fund will have cash to potentially buy back certain shares cheaper should another sell-off materialise.

Outlook
We mentioned the following in our previous commentary outlook section at the end of 2015: "While the tumultuous stock price moves experienced in December are unpleasant on one hand, especially given the reasons which caused it, these periods of indiscriminate selling are also what provides excellent buying opportunities for longer-term investors".

Sure enough, investors who held their nerve and at least held on to their shares through this volatility or even better, bought more on the dips and have already been rewarded with more than a 20% rebound off the lows post the sell-off in December.

However, with the shares rebounding so rapidly and in such large quantum off those lows, the sector is now arguably in slightly expensive territory and we would at this point actually go the other way and caution against investors adding aggressively to listed property at these levels. There is certainly little scope for further such re-rating as experienced over the past three months in our view.

SAPY has re-rated to just a 6.2% (6.6% excluding developers such as ATT and PIV who pay zero dividends) clean forward yield, which is a hefty 300bps premium to the long-bond yield. Also, with SA cash rates rising by 0.75%, and SAPY re-rating to lower yields, listed property yields are less than SA cash (repo is 7%) for the first time in a long while.

However, having issued this cautionary note, over the longer term, e.g. three or more years, we would still expect an inflation-beating absolute total return from listed property of 11%-12% p.a. compounded from current share price levels. This is comprised of an entry yield of around 6% plus 5%-6% CPI-like growth in distributions.

One also needs to factor in that SAPY now consists of around 40% offshore exposure (US, Europe, UK, Australia etc), from zero in 2009. Therefore comparing it blindly to SA bond yields and SA cash is flawed, and one must use a composite index of local and offshore bonds/cash (which are at lower yields) for a fair comparison. Or alternately, we note that the implied yield on SA-specific property stocks (60% of SAPY) is 7.7%, which sounds more reasonable or attractive. Further, one must factor in a view on the currency now, when deciding which stocks to own within the SAPY. Our preference is still a bias towards the more SA-specific, randdenominated stocks as they yield more and have higher local currency nominal growth than stocks with offshore assets, and we believe the rand is cheap against developed currencies at these levels even after already strengthening in Q1'16.