Money: Lighting up property gloom

By PHILIP MACALISTER

The once-popular listed property trust sector has been an unhappy place to park your money recently, especially if you have invested in some of the poorer performing companies such as Capital Properties and Trans Tasman Properties.

Overall, the Stock Exchange's property index has been down 15.5 per cent in the past year. This figure is worse than it looks because it includes both the movements in capital value and dividend yields.

Since the average dividend in the sector has been around the 8.5 per cent mark, the actual fall in capital value for property is 24 per cent.

The three listed Property Leaders index funds highlighted the state of the sector this week when they announced their results for the year to March 31.

Chairman Bill Wilson described the year as "a challenging investment environment.

"Volatile offshore sharemarkets, as well as a general perception that interest rates would trend higher during the year, did not help market sentiment towards listed property companies," he said.

The temptation for many investors when faced with this situation is to sell up and invest in something that looks to have more promise.

Property experts caution people about making such a wholesale change to their portfolios.

"Overall, it [property] is still recognised as an essential part of an investment portfolio," says Ernst & Young director Gary Cheyne.

He says investors need to realise that two of the key factors that drive listed property trusts are the performance of the sharemarket and interest rates.

The New Zealand sharemarket has been a laggard compared to its overseas peers.

The NZSE 40 has traded in a range of between 1950 and 2250 over the past year and has shown no inclination to launch into a continuing upward trajectory as most other sharemarkets around the world have done.

What is more, much of the investor attention has been focused on the "new economy" companies, such as technology and telecommunications, as opposed to the "old economy" stocks such as property.

Secondly, interest rates have a significant impact on the direction of the sharemarket (rising rates suppress the market, while falling rates fuel growth) and on the valuation of properties.

Investors have to judge the return on their property investment against this background.

Mr Cheyne says that relative to the market index, the bulk of the listed property trusts have arguably done all right.

Research from Ernst & Young shows that of the 11 trusts mainly available, the bulk are down between 5 per cent and 10 per cent in the 12 months to May 31. The best of the bunch is the AMP Office Trust, while the worst performer by a large margin has been Capital Properties.

It has been followed by Trans Tasman. The last two companies have large proportions of retail investors.

Another of the laggards has been shopping centre owner St Lukes Group.

The company's shares languished for most of the year, but rose about 20 per cent last month when Australian property group Westfield launched an attractively priced takeover bid.

Mr Cheyne expects there will be further merger and acquisition in the property sector.

Such moves may have positive spin-offs for investors because they make the operations more economic.

Generally-listed property trusts tend to trade at a discount to their net tangible asset backing. That is, when you buy a share in the company you buy it at a price less than the value of the company's assets.

Mr Cheyne says the smaller listed property trusts tend to trade at a bigger discount than the larger companies.

The reasons for this relate to critical mass, management (Mr Cheyne contends that bigger companies tend to have better management teams), brand name and efficiencies.

The trend towards forming bigger groups is not new. Capital Properties recently acquired Shortland Properties, and the Newmarket Property Trust and the National Property Trust attempted (unsuccessfully) to get together.

BT Funds Management equity manager Andrew South says the other main reason for the discrepancy between net tangible assets and share price is that valuers put a price on a building using historical information, while the market values a building on its future prospects.

"Nobody really believes the net tangible assets which are existing at the moment," he says.

Consequently, he expects the trusts to lower the valuations of their properties.

The temptation is there for investors to bail out of listed property trusts now. However, there are good reasons to stay put, and even consider increasing your exposure to the sector.

Mr Cheyne points out that property plays an essential part in a properly diversified portfolio.

While listed property may have lacked sparkle, it is not too bad compared to the other property-type investments, such as owning buildings directly, or investing through syndicates.

Mr Cheyne says one of the key benefits of investing in property through a listed structure is that there is liquidity in the investment. That way you can get out if need be.

Also, he points out, the big issue with discounts is when a business is listed and its share price drops from net tangible asset to a discount.

In many cases buying into an asset which has a large historical discount can be an opportunity because the discount can narrow, assuming the asset is good quality and has good management.

Mr South says the present position in the business cycle may be positive for property trusts.

Assuming we are near the peak of interest rate rises, rates will fall and property trusts will become more attractive.

"There is some good value in the sector for long-term investors."

Mr South says the interest rate cycle is important in determining whether to hold property trusts, but investors need to be aware of other key issues, such as supply and demand, management, valuations and location.

His advice is to look very carefully at the underlying fundamentals.

Despite all the doom and gloom, listed property is seen as a useful defensive investment option in times like this when markets are uncertain.

Earlier this year, the asset allocation committee at the Morningstar managed funds conference decided to overweight its exposure to property - in a portfolio for a 40-year-old investor with an average risk tolerance - primarily because of property's defensive characteristics.

Economics New Zealand managing director Donal Curtin, who chaired the committee, says property is favoured because its high yields are attractive and it has strong defensive characteristics.

Mr Wilson, of Property Leaders New Zealand, says the outlook for property trusts is welcoming.

"The investment climate may still provide an attractive backdrop for listed property companies, as investors search for companies which will provide more stable income streams in the face of volatile capital values in world sharemarkets," he says.

* Philip Macalister is the editor of online money management magazine Good Returns. Good Returns provides news on managed funds, mortgages, insurance, superannuation and financial planning.

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