Investment in listed property can help you beat inflation
By Humphrey Borkum, Chairman of JSE Limited
The property stocks listed on the JSE provide medium and long term investors with an interesting array of choices. These entities give investors the opportunity to partake in a diversified portfolio of expertly managed immovable property. Listed property can help investors find a way to beat inflation - through growth of the capital investment supported by rental escalations contained in the property leases.
There can be no doubt however that the property sector of the JSE has boomed over the past 10 years. This is due largely to the dramatic fall in interest rates over this period. Low interest rates tend to positively affect consumer spending which in turn directly benefits owners in the property sector. When interest rates are high and times are tough companies will generally not take more office space, downsize and in the retail sector, new shops are scarce. This changes the minute the interest rates start to drop.
The market capitalisation of the real estate sector has grown from R41 billion at the end of March 2003 to R335 billion at the end of the first quarter this year. The three biggest companies are Growthpoint with a market capitalisation of R35 billion, Intu Properties (formerly known as Capital Shopping Centres) R34 billion and Redefine Properties R21 billion. Over the last year the FTSE/JSE listed Property Index gave a total return of 35,9% and in the first quarter of 2013 a return of 9,14%. In the past three years we've had 15 companies coming to the market. We now have 44 property companies listed on the JSE which accounts for 3,9% of overall JSE market capitalisation.
The average appreciation in price for real estate unit trusts was about 35% to 40% for the year to date and 75% to 80% for the past three years.
Now the JSE's implementation earlier this month of the Real Estate Investment Trust (REIT) structure
will usher in a new era for the listed property sector and this should help maintain its growth profile.
In July last year I wrote a column on how, after the financial crisis in 2008, the world is moving away from fragmented, uneven risk management to international best practice particularly in the financial sector. The Basil lll regulations regarding bank liquidity are a good example. The new REIT structure is a big move in this direction for the listed property sector. Now international performance comparisons will be easily made and the investor protected within an internationally defined and regulated industry.
More than 25 countries make use of the REIT model including the United States, United Kingdom, Australia, France, Belgium, Hong Kong and Singapore. Spain and Ireland are two Eurozone countries which were badly affected by real estate crises that damaged their banking systems and plunged their economies into recession. These two countries are now introducing the REIT model as an effective conduit to attract domestic and international capital and so underpin their banking systems that are laden with property debt.
In SA, after six years of consultation with stakeholders, the change follows the formal announcement of REIT tax legislation published on 25 October 2012 by the National Treasury. Under this new legislation capital gains tax is no longer payable on disposal of assets. REIT profits are distributed pre-tax and then taxed in the investor's hands.
To comply with JSE REIT listing requirements a company needs to own property worth at least R300 million; have a total debt to asset ratio of no more than 60% and derive 75% of its income from property rentals. It must also distribute at least 75% of its profits to its investors each year. Moreover the company must not invest in derivative instruments that are not in the ordinary course of business and must have a risk policy that is monitored by a committee of the board.
I can foresee a number of benefits emanating from the new REIT structure for both local and foreign investors:
- It will grow our listed property market as there will be increased demand for our property shares
- Many international asset managers have mandates to invest only in property funds with a REIT structure therefore we should have increased foreign investment particularly into the larger listed property stocks which have more liquidity. If all SA's listed property companies convert to REIT we will be the eighth largest REIT market in the world and will be automatically included in foreign funds tracking global REIT indices. For example foreign purchases in our bond market increased when we were included in the Citi Group's World Government Bond Index in October last year.
- The REIT structure enhances property investment for large institutional investors and pension funds
- As a REIT pays no capital gains tax on the disposal of properties the full proceeds of any sale is reinvested in the company
- REITs trade like regular shares and can be purchased through a stockbroker
- REIT shareholders will not pay Securities Transfer Tax on buying or selling REIT shares
- There is a certainty that at least 75% of profit is paid out
People ask me why our property market is so high at present. As I read the situation interest rates are at record lows and quantitative easing programmes in the US , Japan and other central banks have pumped enormous liquidity into the markets. A lot of this liquidity has found its way into property investment.
However there are pressures on the market. These include sluggish economic growth, a lack of development opportunities in prime nodes where land is limited, operating costs are increasing and municipalities are in the process of revaluing commercial property in order to adjust rates and taxes. As an aside I believe golf and sporting clubs are worried about this re-rating which could lead to unsustainable rate increases.
Any prospective investor in the property sector should bear in mind that with interest rates at record lows the next broad move could be upwards.
Bidvests's recent hostile takeover bid for Adcock Ingram led me to muse over the word 'hostile'. In many of these bids the word hostile certainly doesn't apply to the shareholders who often appreciate the benefits that would accrue from the takeover. Thus the word hostile most frequently applies to the 'top brass' in the target company because, from my experience, they know that if the takeover is successful, it is likely that many of them will all be out of a job in two to three years time.
There are numerous defensive measures available to companies to defend themselves against hostile takeovers. These are collectively referred to as 'poison pills' or as 'shark repellents'.
One of the most common poison pills is a provision that allows current shareholders to buy more shares at a steep discount and a more drastic method involves deliberately taking on large amounts of debt.
In my opinion one of the problems of a bid being considered hostile is that the bidder is unable to conduct extensive due diligence into the affairs of the target company and is limited to only publicly available information. Banks are often less willing to back a hostile bidder because of the relative lack of information on the target company which is available to them.
In South Africa complex legal wrangling seems to be the most common poison pill. This often leads to the suitor becoming discouraged with the time executive staff have to allocate to the acquisition and the expenses that are incurred. In a relatively small market like South Africa matters also become complicated when both companies could have the same bank and the same asset managers owning most of the shares. These asset managers don't necessarily want to see their turf shrinking if a target company is delisted.
To my mind the possibility of a takeover, hostile or otherwise, keeps directors and management on their toes. The most successful takeovers in SA seem to have been in the property market and look how well this sector is doing. The vast majority of these takeovers or mergers were, however, friendly.
This article first appear in Business Report