Property shares: Reason for concern, or an opportunity?

Any clothing sale has to be my worst nightmare. Aside from the fact that they never have stock of the size items I like, the most frustrating aspect of these sales is that winter sales usually happen towards the end of winter, and summer sales usually happen around the time you start looking for something warm to wear. 

Without knowing it, my daughter gave me the idea for this edition’s article when she cleverly pointed out that she uses these sales to buy clothes at discounted prices, even if it means that she would have to wait for the next appropriate season to wear them.  

Local property shares (Index J253) managed to grow by 15% per year between the beginning of 2008 and the end of 2017. 

The really remarkable thing about this figure is that this period included one of the greatest corrections of all time (2008) and, more importantly, that it managed to outperform local shares (FTSE/JSE All Share Index) by nearly 5% per year over the same period.   

Just like the price of summer wear at the beginning of summer, towards the end of 2017 these prices finally started to trade at levels where finding bargains became less and less likely. 

Mix together the inflated share price levels with the fact that a dark cloud had started to appear over one of the index’s largest companies, Resilient (and its sister companies Greenbay, Fortress and Nepi Rockcastle), and you have a recipe for disaster to such an extent that as at 19 June 2018 the FTSE/JSE Listed Property Index (SAPY) was already down by 21% for the year.   

When we compare this to the other four main asset classes (local shares, local money market, local bonds and offshore investments [consisting of 60% shares and 40% bonds]) to determine its relative value, it becomes clear that SAPY hasn’t traded anywhere close to discounted levels since 2013.   

These five asset classes each have a historical return figure and comparing these figures gives us a good indication of just how cheap or expensive they are trading relative to one another. 

When we take a look at property shares, for example, we learn that this index’s average dividend yield (which does not consist entirely of dividends alone) has been trading at a historic average of 104% (1.04 times) that of the other four asset classes’ returns (money market, local shares, local bonds and offshore investments) over the last 15 years.      

By the end of 2017, this ratio declined to just below 80%, which effectively pointed out that relative to the other four asset classes, it offered less value in terms of prices at the time. 

Although those prices couldn’t be considered as historically absurd, red lights were starting to flash.   

The most recent data shows that this ratio has now increased to 130%, which is considerably higher than the historical average of 104%, but also one standard deviation higher than the 15-year average. 

This is a sign that either something may be wrong with local property shares that we haven’t yet managed to put our fingers on, or that an opportunity is starting to present itself to investors.   

We took things one step further by also investigating individual property shares. First, we looked at what their underlying fair value should be relative to that of long bonds in South Africa.

We then looked at what their fair value should be when we place their long-term average relative to its current price-to-book ratio. 

Finally, we looked at all South African analysts’ consensus price forecasts (according to Thomson Reuters). 

These ratios and values all showed us that property shares are gradually starting to enter a bargain phase.   

SAPY makes up about 6% of the total FTSE/JSE All Share Index, and Growthpoint (largest) and Redefine (second-largest) make up about 2% of that 6%.

At an average discount of approximately 15% compared to these two companies’ fair value, I do feel that investors can slowly but surely start to accumulate these shares in cases where their portfolios are still underweight.   

It’s crucial for investors to note, however, that much like my daughter’s bargain-hunting strategy, they may have to wait a season or two before their purchases come back into style. As they say after all, “good things come to those who wait”. 

Schalk Louw is a portfolio manager at PSG Wealth

This article originally appeared in the 5 July edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

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