Market Review
The SA Listed Property Index (SAPY) returned a total of 5.7% in Q3’17, 8.2% year -to-date (YTD) and 9.5% on a trailing one-year basis. YTD is has now outperformed bonds and cash but it has marginally underperformed equities, as measured by the ALSI or SWIX indices.

The best performing shares in the SAPY for the quarter included the shares with 100% foreign exposure such as MAS Real Estate, NEPI Rockcastle as well as Greenbay Properties, which only recently entered the SAPY Index. This was driven partially by good fundamental earnings growth, partly by rand weakness in the quarter. Conversely, shares with more pure-play SA exposure were some of the underperformers, such as Hyprop Investments, which derated substantially from well under a 6% dividend yield (DY) to over a 6.5% DY in the course of the quarter. The SA Corporate Real Estate Fund also fell substantially from its highs.

As has become customary in the sector, there were again numerous capital raisings via bookbuilds, including raises by Equites Property Fund, MAS Real Estate, NEPI Rockcastle, Greenbay Properties and Resilient Property Fund, with approximately R15 billion raised in total.

In terms of recent earnings releases, while cautious on the outlook in South Africa, some of the larger, predominantly SA-focused REITS such as Growthpoint Properties and Hyprop still actually delivered healthy growth in dividends of 6.5% and 13% respectively, with guidances of 6% and 8% for the next year respectively. However, some of the smaller/mid cap SA-focused REITS such as Emira Property Fund and SA Corporate with poorer quality Office/Industrial exposures are struggling to deliver real growth (above CPI) in dividends for the past year given negative rental reversions and/or higher vacancies.

What SIM did
Before fees, the SIM Property Fund returned 5.1% for the quarter, unfortunately underperforming the benchmark by about 0.7%. YTD the fund returned 7.9%, marginally underperforming the SAPY by 23 basis points (bps). Finally, over a 12- month period, the fund returned 9.7%, marginally outperforming the SAPY by 20 bps.

Following increased dispersion in returns of the 100% offshore companies such as MAS Real Estate, NEPI Rockcastle and Greenbay, which delivered substantial outperformance, rerating to lower yields of under 4% and lofty premiums to book value, we reduced exposure to these shares in favour of higher-yielding and/or lower P/Book rand hedges such at Intu Properties (6% DY, 0.6 x book), Capital & Counties Properties (0.8 x book), Investec Australia Property Fund (7% DY), Redefine International PLC (7% DY), Echo Polska Properties (8% DY) and Stenprop (7% DY).

Amongst the SA-focused REITS, we remain zero weight Equites, which entered the SAPY, as it trades at a premium rating of 6% DY and 140% NAV versus thelikes of Growthpoint and Redefine, which trade above 8% DY and at book, or Delta Property Fund and Rebosis Property Fund, which trade above 10% DY and well below their book values. Attacq signalled its intention to convert to a REIT, however, only guiding to being able to pay a 4% forward DY, also a sharp premium to other SA peers. We thus also sold Attacq to an underweight position, which together with Equites funded our more material overweights in much higher-yielding, lower P/Book Growthpoint, Redefine Properties, Delta and Rebosis. We also finally closed our underweight position in Hyprop at an attractive 6.5% DY given its quality. We also carry smaller offsetting overweights in a mid-caps basket including Emira, Octodec Investments, Arrowhead Properties, Accelerate Property Fund and Tower Property Fund, yielding about 10% on average.

Overall, the fund still remains balanced in terms of its exposures to SA/offshore income streams, split roughly 65% SA and 35% offshore, given uncertainties on currency moves, and our political instabilities. So as per the comments above we have attempted to do stock picking within each of offshore and SA exposures, as opposed to trying to take a substantial macroeconomic view or position by being substantially overweight or underweight offshore exposures for example.

Outlook
The SAPY is currently trading on a 7.2% clean forward yield, with two-year expected growth in dividends of about 7% p.a. and, in our view, longer run growth in the CPI range of 4-6% p.a. This yield is now a 140 bps premium to (i.e. below) the long bond yield. This spread versus bonds has narrowed from as high as 260 bps in Q1’16, on account of local bonds outperforming the SAPY, with the SAPY derating over that 18-month period from 6.6%, as capital values haven’t really moved to keep pace with dividend growth. The implied average yield of just SA-specific counters is much higher, at 8.5%.

We consider these levels to be marginally cheap on average, in absolute terms, and rather attractive on a relative basis, especially for the long-term investor, when compared to bonds and SA cash. Over the longer term, e.g. three or more years, we would still conservatively expect an inflation-beating absolute total return from listed property of 11-13% p.a. compounded from current price levels, comfortably expected to beat all of inflation (5%), cash (7%) and bonds (9%), and possibly on par with even general equities. This expected total return is comprised of the c.7.2% average entry yield plus conservatively assumed longrun CPI-like growth in distributions in the 4-6% band, even though shorter-term growth for the sector and SIM Property Fund will likely even exceed CPI.

While political turmoil and rating agency downgrades may prove to be a hindrance, the numerical facts of a stronger currency, declining inflation within the inflation bands, and lower average oil prices (which further pushes inflation down) could lead to further, albeit shallow, rate cut/s over the next six to 12 months. This could potentially be a positive for the sector, especially the SAbiased shares. This is due to the companies being leveraged, with typically 35- 40% debt to assets, hence finance costs fall in the event of rate cuts, boosting distributable dividends, as well as making it just a bit easier to do accretive debt/equity-financed acquisitions. Secondly, lower interest rates mean the competing asset classes of cash and bonds now offer lower returns, which may lead to some investors switching into riskier/growth asset classes such as equities, including property.

Thus, political and downgrade woes aside, the fund still actually maintains a very healthy (65-70%) absolute weighting to SA type exposures (Hyprop, Growthpoint, Redefine Properties, Delta, Rebosis, etc.), as we feel their derating to attractive yields adequately compensates long-term investors for the macro risks. As mentioned above, the SA-specific exposures are currently providing an implied yield of 8.5% versus the overall SAPY average of 7.3% (which gets dragged down by the lower-yielding pure offshore counters such as NEPI Rockcastle, Greenbay and MAS Real Estate at 4% yields or non-yielding shares such as Attacq).

Market Review The FTSE/JSE SA Listed Property Index (SAPY) returned a total of 1.26% in 4Q16. For the full calendar year of 2016, the sector returned a strong 10.2%. In 2016, the sector was the second-best performing domestic asset class. It outperformed SA equities (2.6%) and SA cash (7.5%) but underperformed SA bonds (+15.5%). As a matter of interest, on a total return basis, SA listed property has actually proven to be the best performing of these four asset classes, and by a considerable margin, over three-year, five-year, 10-year and even 15-year periods.

The best performing shares in the SAPY and the SIM Property Fund for 2016 included the likes of SA Corporate, Rebosis, Delta, Growthpoint and Redefine, which rebounded off very depressed levels or high dividend yields post the Nenegate sell-off in December 2015. These are shares with predominantly SA and hence rand exposures. In contrast some of the worst performing shares included rand hedge stocks or stocks with UK and EU exposure, including Resilient, Stenprop, MAS plc, Nepi, Rockcastle, as well as Intu and CCO. This was on account of Brexit combined with the rand strengthening sharply off its worst levels towards the end of 2015, e.g. c.25% stronger against the British pound year-onyear.

What SIM did
Before fees, the SIM Property Fund returned 1.63% for the quarter, and 11.88% for the 2016 calendar year. This represents 37bps outperformance for the quarter, and 168bps outperformance over the past 12 months.

As mentioned above, rand hedge stocks underperformed materially due to rand strength and fears of rapidly falling UK property prices/rentals on account of Brexit for the shares with UK exposure.

We introduced a position in Stenprop for the first time, with the share yielding close to 8% in Sterling, and on the back of being the worst performer in the SAPY in 2016. We also continued reducing our big underweight in Resilient as it underperformed the SAPY substantially in 2016, and was hence one of the major contributors to the SIM Property Fund outperforming. This was funded by reducing or rebalancing the fund’s largest overweight positions in Rebosis and Delta, as both materially outperformed the SAPY in 2016, hence also contributing to the fund outperforming. We also added to Rockcastle, reducing a big underweight there as it also underperformed in 2016.

As mentioned previously, we were heavily favouring higher-yielding randdenominated counters over offshore counters going into 2016, as we were of the view that the rand is cheap and were hence underweight offshore exposure relative to the SAPY offshore exposure of close to 40%. However, on account of the rand strength in 2016, combined with the stock price weakness of the abovementioned rand hedge stocks and strong stock prices of certain SA-based stocks, we have effectively upped direct and see-through offshore exposure in the fund closer to the effective SAPY offshore exposure of c.40% by implementing the above trades.

Outlook
SAPY is currently on a 7% clean forward yield, with two-year expected growth in dividends of about 7% p.a. This yield is now a 180bps premium to (i.e. below) the long bond yield. Also, with SA cash rates rising 0.75% this year, listed property yields are exactly in line with SA cash (Repo is 7%). The spread versus bonds has narrowed, however, from as high as 260bps in 1Q16 on account of our local bonds rallying and the SAPY derating slightly, from 6.6%, when it also yielded less than SA cash. The implied average yield of just SA-specific counters is higher, at close to 8%. The net asset value (NAV) premium on the SAPY sits at 16% currently following recently reported increases in NAV for certain shares.

We consider these levels to be more or less fairly priced on average in absolute terms, and attractive on a relative basis, for the long-term investor, when compared to bonds and SA cash, considering listed property gives you growth in income distributions while bonds and cash do not. 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%-13% p.a. compounded from current share price levels, comfortably expected to beat all of inflation, cash and bonds. This expected total return is comprised of the c.7% average entry yield plus conservatively assumed long-run CPI-like growth in distributions, even though shorterterm growth will likely even exceed CPI.

Our comment in the market review section of long-run SAPY performance versus other asset classes also cements a view that listed property undoubtedly does warrant some level of exposure in a balanced portfolio, even if the historic level of outperformance is unlikely to be repeated given today’s entry yield of 7% being lower than the double-digit entry yields 10-15 years ago.