South Africans who invested in listed property would have earned excellent returns over the past eight years; and, while the phenomenal annual rates of return of up to 60% experienced in the past may be slowing, the yields on listed property continue to present a solid long-term investment option for investors, particularly those who pay low or little tax.
South African listed property held up remarkably well during and after the sub-prime crisis because listed property companies generally had much sturdier business models and didn’t fall prey to the same overdevelopment and gearing experienced elsewhere in the world property market.
In relation to bonds, listed property offers relatively high – and growing – yields. While property yields tend to be somewhat lower than yields on bond funds, yields rise annually as a result of contractual rental escalations, which currently range from six percent to ten percent.
For this reason, the asset class is particularly suited to elderly investors, who may pay little tax, and charities that are exempt from taxes.
For younger investors, the equity-like characteristics of the asset class are attractive. Listed property offers capital growth, albeit at a slower rate than is likely from equities, given that income in listed property is fully distributed rather than reinvested.
The industry is likely to undergo various changes in the future and these could further boost demand for the asset class. Currently, South African investors can either invest in a property unit trust (PUT) or property loan stock (PLS), but these investment vehicles are largely unknown to international investors, so to attract more foreign investment, the industry is planning to amalgamate the two instruments into a structure called Real Estate Investments Trusts (REITS), which is the global standard. There are numerous types of listed property structure, each of which strives to pass rental income through to investors without incurring tax within the structure.
Property unit trusts are based on the collective investments/ unit trust structure. Accordingly, neither income tax nor CGT are payable within the structure.
The drawback is that management is implemented from a separate manco structure, which may result in conflicts of interest between unitholders and the manco, in particular since the fee mancos charge is based on the value of property assets (which rewards size over quality). There is also a Trustee, which may impose restrictions on investment and gearing.
Property loans stocks have a capital structure which combines a relatively small equity portion with a large debenture or debt portion. (This structure is more common in small private firms, which may have a shareholder loan.) Rental income is used to pay the debenture interest. Income tax is not paid within the structure, but CGT is, reducing returns on re-investment.
REITs are the global standard for listed property investment. They are a corporate structure which provides the same benefits as the PUT collective investment structure without the restrictions of manco separation and Trustees. Unlike PLSs, they are not liable for CGT. To transfer assets into a REIT structure, PLSs may have to pay a portion of their unrealised capital gains tax to compensate SARS.
So, notwithstanding prevailing market conditions, it is worth having long-term exposure to listed property because of its diversifying qualities and its yield; the fact that listed property exposure is asset-backed, with physical assets underlying the holdings, and given the industry’s recent resilience to adverse global economic conditions, which highlights that listed property funds are well managed and fundamentally sound investments.