Surviving property's slump
Property investment vehicles have come into sharp relief following the downturn in this once buoyant sector. Philip Macalister reports on the issues.
Thursday, October 15th 1998, 12:00AM
New Zealanders have an enduring love affair with property, but that relationship may be poisoned by recent developments.
For the past five years investors have enjoyed the strong and rising returns from property as an asset class, but now it seems the cycle has turned.
Spicers research manager Aaron Hing says recent figures suggest commercial property is moving into a downturn. The commercial property component of the Spicers Personal Investors Index dropped 0.6 per cent in June and that trend has continued.
Hing says that the June fall was the first property had experienced in almost five years. Further to that commercial property has risen only 7 per cent before tax for the 12 months to July 31.
"This has been the lowest annual increase in four years," he says. Since July, the returns from property have continued to fall.
Armstrong Jones general manager property David Blight predicts the next 12 months are going to be rough for the sector.
This outlook is concerning managers and advisers that deteriorating returns and sentiment in the sector will be a catalyst for investors to sell up. This concern is raises the prospect that the unlisted property sector may be in for a rough time as happened in Australia in 1990.
Then the whole unlisted property sector collapsed because investors wanted out and forced buildings to be sold at fire sale prices in a depressed market.
Blight, who was in Australia then, says such an occurrence here would be a major problem as so much money has gone into property since 1993.
The listed property sector has ballooned from $420 million to $2.58 billion, and it has seen a number of major listings, including St Lukes Group, Kiwi Income Property Trust and AMP Office Trust.
This sector isn't the at risk one though as its growth is the result of investor demand for liquidity and diversification.
The concern centres on the unlisted sector, (represented by syndicators such as Waltus, Dominion Investment Trust and St Laurence Group) which has raised significant amounts of money from retail investors in the past five years.
How much though is one of the great unknown factors. Some estimates put the total figure between $600 million and $700 million.
Blight says the big negative for unlisted property is its lack of liquidity. He says from this perspective these vehicle are "fundamentally flawed.
"When the market turns everyone wants to get out, but you can't sell the asset at the right price," he says.
That leads to a related problem - pricing.
Unlisted, syndicated or directly held property is priced by the valuation profession on an annual basis using historical data. Blight says this method only gives a guide to a property's actual value and it doesn't reflect account for changing economic fortunes.
Pricing of listed property trusts is far more efficient than their unlisted counterparts as it is priced by the market on a daily basis.
Blight says this means the pricing better reflects economic conditions and it allows investors to accurately re-weight their portfolios.
"Listed property trusts have historically been a leading indicator of where the market is going in the next 6 to 18 months," he says.
On this basis the price of listed property is determined by interest rates while unlisted property is more closely related to gross domestic product and economic growth.
Blight describes listed property as being forward looking, and pre-empting change, while direct property is backward looking and is priced on historical information.
This can give investors with direct property a false sense of security when the economy goes into a decline like New Zealand is experiencing at present.
Blight says property returns are falling and investors used to getting more than 10 per cent annually from their holdings should be looking to a return of around 7 per cent at present.
He says a number of buildings have seen their capital values fall, and the only thing propping up the returns is the strong income streams.
"We've seen some negative revaluations," Blight says. "The saving grace is the income stream."
Blight says, although there are problems with directly held property, there is room for both listed and unlisted property in an investor's portfolio and investors need to understand each one's unique characteristics. (For more on this see earlier feature).
The liquidity problem can be ameliorated (to a degree) by having syndicates with a fixed term (say five to seven years) where investors are locked in until the end. This period could be subject to extension.
Some of the benefits of direct property are that because it is only valued annually it is less volatile (and more thinly traded) than property securities listed on the Stock Exchange.
Also unlisted property should, arguably, give better returns as it should have lower management fees, but part of the trade off is that the risk is higher.
With property management has a greater ability to add value. Blight describes it as "the only asset class you can add value to over and above the market by the quality of your management."
Among the value-adding options open to management are decisions such as undertaking building or lease extensions.
One of the big questions investors face when they considering listed property in their asset allocation process is should be considered as an equity or a property investment?
Blight's strong view is that it should be considered a separate asset class altogether. In the short term listed property correlates strongly with the equity market, but over the longer term its performance is closely correlated with the underlying asset's performance.
In the next 12 months that performance may not be too great, however the outlook is for a pickup in the next 12 to 18 months, Blight says.
In the meantime, all the unlisted property syndicates will have to work on staying in tact.
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