Strong momentum led the listed property sector higher thus far in 2012, which was very similar to
what happened towards the end of 2011. The sector was also supported by a
combination of lower bond yields on the back of a stronger rand and some
blanket buying that might have taken place to gain exposure to the sector. In
addition, another boost for the sector was probably a renewed focus on
potential corporate action as both Redefine and Capital announced the potential
acquisition of Fountainhead and SA Corporate respectively. We may see some
potential bid premiums being priced into other stocks which the market may view
as potential take over targets. Smaller new listings into the sector continue
to take place with Ardor, Annuity and Hermans & Roman being the first of
the next prospective wave to follow the 6 new listings in 2011. The viability
of some of these listings remains in question as many assets going into them
are being recycled from existing listed property companies. After recording the
third highest monthly value traded in February, trading values reached record
levels in March, outperforming the previous record level by approximately R1 billion,
or close to 20%. These levels of trade pushed the sector to delivering a total
return of close to 11% year to date.
The February Budget speech confirmed the alignment of the tax treatment of the property loan stock
(PLS) sector with that of the property unit trust (PUT) sector with the
introduction of real estate investment trust (REIT) legislation as early as
2013. This process already started back in 2007. We believe that this will have
a positive impact as the sector will then be directly comparable to other
international markets with REIT legislation. The PLSA indicated that at present
the likelihood of a conversion charge to the new structure will be small,
thereby resulting in the current deferred capital gains tax liabilities not
realised and thus pushing NAV levels higher.
Some reflection after the February/March results season points to a number of interesting
trends. Although the sector delivered a weighted average distribution growth of
7.5%, the resulting full year distribution growth of 5.7% for 2011 was the
lowest since the 4.2% delivered in 2004, which reflects the challenging
underlying operational environment. Pressure on top line growth remains, with
operating cost pressure making it difficult to increase rentals as tenants
consider total occupancy costs. Higher tenant retention ratios have come
through this reporting season, which is promising, but definitely at the
expense of rentals. We will have to see what the April/May results season
brings and if there is an improvement in the operating conditions.

Other trends within the sector include signs of some improvement in the retail sector as well as industrial
properties associated with distribution and logistics; offices, especially
B-grade offices, continue to struggle. Funding costs continue to decrease with
the lower interest rate environment being used to enter into interest rate swaps
and even forward starting swaps at levels below 9%. To diversify away from a
dependency on traditional bank funding more funding avenues within the capital
market are being sought. The move into so-called quality properties continues,
where smaller, multi tenanted properties are disposed of in favour of larger
single tenanted properties. At the moment, this move is mostly yield
dilutionary as it seems some price chasing is taking place with most of the
smaller properties being sold returning to the listed space through some of the
smaller listings. Most of these acquisitions seem to be taking place in the
office sector, while the transactions seem to be taking place with some kind of
related party, or between parties where a strong established relationship
exists.
An increase in defensive capex, and on a larger scale, is being noticed to ensure that
properties remain competitive in a challenging market. With A grade offices and
industrial properties performing the best on a relative basis, some speculative
office and industrial developments are being initiated by landlords. However,
despite comments relating to construction margins being favourable, development
yields are decreasing.
Although inflationary risks remain within the system, local bond yields continue to
trade more in line with global bond markets, which remain at low yields.
Despite operational challenges remaining within the local property market, some
bright spots are emerging, which point to a potential distribution recovery in
2013. This is where the importance of management teams and their experience in
operating through past property and interest rate cycles come into play for
individual stock selection. These two factors will support current share price
levels in the short to medium term, making tactical asset allocation decisions
difficult. We see the momentum of the last few months to continue, but at a
slower pace.