Investment Matters

Property defying investment gravity?

We often think of 'the market' as a homogeneous entity.  The reality is anything but.

It has been an interesting exercise to compare the performance of different sectors to the market for the post-GFC recovery.  This week's Investment Matters focuses on a disparity of particular note - listed property, as compared to the market (as represented by the ASX200).

Please note that the discussion below pertains to the listed property market only (not residential).  The listed market relates mostly to securities of office, industrial and retail (e.g. shopping centres) properties.

Caution relating to the property sector

In past IMs we have noted our caution in relation to listed property.  As a brief re-cap:

1. a large premium exists in the price many listed property trusts are trading at, compared to their net asset valuation;

2. we are cautious about asset valuations themselves (being often, at least partly, based on comparative techniques, and are thus being driven up by the prices overseas buyers are willing to pay);

3. income, from rental streams, is showing signs of being crimped, and / or is being artificially inflated through the use of incentives; and

4. we are concerned about the future cost and availability of debt (and the potential flow-through to earnings).

A post-GFC comparison

The following chart depicts the monthly performance of the property index to the market (ASX200), subsequent to the GFC lows in Mar-09. 

Listed property securities

Since the GFC low on 6-Mar-09, the property accumulation index has increased 287.4% (=20.5% annualised), compared to the ASX200 accumulation index, which has increased 134.9% (=12.5% annualised).

From a capital only perspective (i.e. ignoring income / distributions), the property index has more than doubled in the 7.25 year period.

Does it make sense?

No!  The property sector did fall considerably during the GFC.  However this subsequent rise is, as discussed below, now significantly out of kilter with property fundamentals.  Furthermore, it is out of keeping with GDP growth (which property growth should be loosely aligned to).

Then why?  It is difficult to specifically identify the drivers behind the property sector's movement.  We believe there are three main factors:

1. chasing income (just as in the broader equity market we have seen the chase for dividends);

2. perceived safety of property investments (perception is not always reality!); and

3. weight of money - large amounts of cash (e.g. from superannuation funds) trying to find an investment home.

Returns over the last financial year

The First Samuel property allocation (which you may or may not have depending on your investment programme) has performed strongly this year absolutely.  It is up ~10.3% FYTD.

However, the property index (XPJAI) is up 21.8% FTYD.  And this is on the back of strong growth post the GFC (as noted in the graph above).  The equity market (ASX200) is up 2.9% FYTD by comparison.  I never thought in my investment lifetime I would see a return figure like this from property - it is meant to be a lower risk, and return, asset class than equity.  Additionally, returns are meant to be quite correlated with economic growth; driven fundamentally by rental income and the growth of rental income.  Our economy is certainly not growing at 21% p.a.!

Hence, First Samuel's property allocation will have negative relative performance for FY-16.  That said, as we have articulated many times in the past, we do not seek to outperform the property index.  Instead, we are focused on providing sustainable income with some capital growth to provide a hedge against inflation (supported by underlying rental receipts) - as well as diversification.  Capital preservation is a key focus (which can't be guaranteed in the immediate term, but is certainly our focus in the longer term).

Our investment response

Over the last year or so we have noted our cautious approach to property investments.  In recent months, we sold two of your property investments - Generation Health Care (based on share price, as compared to valuation including net asset value), and National Storage (based on share price vs valuation, and also being higher risk / more aggressive operationally).

The Property allocation currently has 17.8% cash.  We continue to manage the allocation very conservatively, especially given all we have highlighted above.