The property-unit trust link

A Fin24 user wants to know about the relationship between property and unit trusts. He writes:

What exactly is the relationship between property and bond market unit trusts? What, why and how do they effect each other’s performance?

Candice Paine, head of retail at Sanlam Investment Management, responds:
 

The relationship between these two unit trust types depends very much on market conditions.

During negative equity markets there is a strong correlation between the performance of property and bond unit trusts, but this gradually weakens during more favourable equity markets.

This is largely because while property unit trusts are generally affected by factors similar to those of bonds, they begin to behave slightly more like equities as equity markets start showing favourable returns.
 
Essentially, there is a strong negative correlation between them, meaning that as bond and property yields go down, property and bond prices go up. See graphs below.
 





 
More insight can be gleaned by analysing property unit trusts more deeply.

Simplistically, property yield is equal to the income you earn from property divided by the price of the property. So if the yield on property is 10% with income of R10, the price (value) of the property is R100.

If you were to continue earning R10 income and the yield on property came down to 5%, the price of the property would be R200 (demonstrating the yield/price relationship).
 
Property has both bond and equity characteristics.

(Rental) Income from property companies can be predicted with reasonable certainty, much the same as certainty of cash flows (interest) payments from bonds. (This explains why property yields tend to be compared with bond yields.)

Valuations of property also change over time, therefore adding a capital gain/loss to the return on property (equity characteristic) and this applies equally to bonds.
 
As with equities, listed property offers prospects of distribution growth. Growth is lower than for equities over time, partly because all income is paid out. Equities derive returns on retained income, which contributes to dividend growth.
 
Property unit trusts offer true diversification. They allow investors to diversify the volatility of their portfolio as property has a low correlation with other asset classes, and the added income stream from the property sector allows investors to add to the sources of return.

It is worth noting that rental growth generally lags economic recovery.
 
Bonds offer interest income and diversification too and thus are a regular feature of any balanced - or other multi-asset class - unit trust fund.

 - Fin24

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