Musing about… Property Returns

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Property investment funds have had a stellar year… Just a quick ponder today, with a focus on the managed property investment scene. The area of interest is specifically the rates of returns currently showing for property investors in the major managed investments. This post has been prompted by recent advertisements which start with the returns for this or that fund over the past 12 months. i’d like to put some of this into perspective, and look at it from a financial planner’s point of view rather than that of a marketing agency or a funds management group.

By way of update, i wrote this note at the end of January, and am only now getting around to posting it to the site. Have a look at how returns in the property market have moved since that time…

listed property trust returns

A year ago there would have been very few people who would have drawn a chart like this as the future 12 months for the listed property trust market.

 

Financial Planners are biased towards the long term

The statement “financial planners are biased towards the long term” is not made flippantly. It’s a specific restatement of the basis under which most financial planners operate.  The whole idea of “long term” has been kicked around a bit in the last 5 years Post-GFC, to the point where mainstream interpretation of “financial planners bias towards the long term” no longer reflects the meaning that financial planners give it. So i am going to restate the concept by focussing on this one area of property market returns.

Property Markets have had a good year!

We are talking institutionally managed property here – residential property has been in a slump around the country, and most managed funds do not invest into residential property as such (although they may develop residential properties).

The specific advert that triggered this post headlines with the returns of the fund over the past 12 months – a bit over 33% net of fees. That is a spectacular return in anyone’s language, and will undoubtedly immediately attract interest and attention to the underlying investment product. What is important to those who consider investments professionally, is the level of outperformance. In other words, how does that performance compare to the performance of the property market itself? The advert correctly includes the comparison of the benchmark index returning 25.8% for the year (i am not going to be more specific than that, as the particular fund is less important than the idea under discussion). That is an “excess return” of 7.9% for the year. This is an incredibly good performance.

Now we will look at that same performance from the point of view of a financial planner.

Property Securities have returned 29% in the last 12 months

The first port of call for a financial planner is to identify the correct benchmark. In other words, where is your money going to end up, and does the benchmark selected appropriately reflect that investment mix?

In the case of this advert, the relevant benchmark is the S&P/ASX300 A-REIT Accumulation Index. That is, the property securities that are listed on the stock exchange in Australia that are included in the top 300 companies index, with dividends included. A financial planner would be aware of another similar index – the S&P/ASX200 A_REIT Accumulation Index. In other words, there is an index that excludes some of the smaller companies, which may invest into more niche sectors or that lack the scale to focus on the highest grade properties. In practical terms, the broader “300” index property fund has 19 listed securities compared to 16 listed securities in the “200” index. So there are only 3 investments separating the two benchmarks. It’s quite difficult to locate the relevant code for the “300” index so i have used the Vanguard listed Exchange Traded Fund (“ETF”) as a proxy. This fund has the code VAP on the Australian Stock Exchange. The 12 month return i calculate is 27.8%, versus the “200” (security code XPJ) property accumulation index return of 29.01%.

Why am i boring you with the semantics of this benchmark vs that? i bore you with it as this is the work of a financial planner. What the average person dismisses as insignificant, the financial planner sees as a cause for investigation. In the case of the advert under discussion, that difference between the two benchmarks equates to 1.21%. And that is simply from including or exclusing 3 companies. So comparing the relative performances of investments requires highly specific and clear statements of the basics.

 It’s a bit like the story of the wife who asks her husband “could you please go shopping for me and buy one carton of milk, and if they have avocados, get 6”. The husband returns with 6 cartons of milk. His wife asks him “why did you buy 6 cartons of milk?”. He replied “they had avocados”.

Property Index components

Here’s a listing of the companies included in the S&P/ASX200 A-REIT Index.

  • ABP Abacus Property Group
  • ALZ Australand Property
  • BWP Bunnings Wharehouse Property Trust
  • CFX CFS Retail Trust Group
  • CHC Charter Hall Group
  • CPA Commonwealth Property
  • CQR Charter Hall Retail
  • CRF Centro Retail Australia
  • DXS Dexus Property Group
  • GMG Goodman Group
  • GPT GPT Group
  • IOF Investa Office Fund
  • MGR Mirvac Group
  • SCP SCA Property Group
  • SGP Stockland
  • WDC Westfield Group
  • WRT Westfield Retail Trust

For the anal retentive amongst us, yes there are 17 securities when i suggested 17… The two Westfield operations are still dealt with as one security on even major institutional websites. Just another one of those little things that a financial advisor is going to want to check. Let’s look at the 12 month performance of around half those securities. I’ve simply started with Australand and added securities with a similar price level (because it helps to keep the perspective correct for charts that i have access to).

11-12-2012 Listed Property index comparison of some constituent securities returns

Some of the individual performances have been outstanding – even amongst a generally outstanding field of property companies.

The point to note here is just how well some individual companies have done. Clearly, the greater your exposure to the securities that have done well and the lower your exposure to those with lesser returns then the better your individual performance will look against the benchmark.

Property Returns

Now for the average fund manager/ sales website/ investment newsletter, that’s about as far as the investigations would go. However, a financial planner must take a different approach.

A financial planner will want to know why you are investing into property in the first place? Traditionally this is for a higher level of income and the possibility of some capital growth. In other words, access to the strong rental incomes offered by high grade commercial property (technically, commercial/ industrial/ office/ diversified) and the growth that comes from the increasing replacement value of the building itself.

The past year returns have been extraordinary. That’s important. They have been EXTRA ordinary. In other words, anything BUT ORDINARY! Which means that the past 12 months’ returns are almost worthless as an indicator of anything to do with the underlying properties. They have been predominantly related to non-property issues, and that is where a financial planner’s assessment will differ from most other investors’ outlook.

The last 12 months has seen a global lowering of interest rates, with the outcome of rental income looking comparatively better. The property market itself has been struggling to overcome the lingering impact of the banking crisis, which has kept investors away – but with the slow lifting of bank restrictions, those investors have begun to reconsider property as an investment. For example, “balanced” funds usually included 3% to 7% in property prior to the GFC, whereas many moved to specifically exclude a property component post the GFC. These large institutions altering their exposures can have big impacts on the shareprices of this small sector of the market.

In other words, the past 12 months could actually be an indicator of reduced returns for the near future, as some of these factors alter or even reverse. This brings about an element of “timing risk” to an investment at this point in time. Such a risk could be moderated if a person has a long term view, and if they are able to cope with capital volatility while receiving the income from the property based investments.

Longer term property returns

The financial advisor will also want to put the recent returns into perspective. It’s great to look in wonder at 12 month returns but what about the longer term? How have investors fared in these investments over moving market cycles? As it turns out, in pure “capital terms” (ie, the ongoing value of your initial investment as opposed to the ongoing income earned) the answer is “badly”. Here’s a look at the 5 year returns of those same 6 property securities.

11-12-2012 ASX Listed Property index component charts 5 years

Although the last 12 months returns for property securities have been appealing, the longer term post-GFC does not look anywhere near as good. This highlights the expanded risk to capital that can occur in a property investment.

The important thing to take away from this is the similarity of returns between the different companies. Some have clearly done better than others in retaining their price and value – but regardless of who you choose, your capital has taken a large hit by being exposed to this section of the market.

In the five year period, capital invested into property securities has been hit very, very hard. If you were able to make a purchase at the base of the GFC – back in March 2009 – your investment into the S&P/ASX200 A-REIT Index would have increased by 118% (if we include dividend income).

In other words, listed property securities have fallen further and recovered by a larger amount than the overall Australian sharemarket. An investment into the broader market would have retained more of its value 5 years later but you can see the incredible volatility in terms of outcomes that listed property investors have had to cope with in these last 5 years.

So a new investor who did not look further than the current advertisements would have a greatly different view of investment into property securities than would someone who made the bulk of their purchases prior to the 2007/2008 global financial crisis peaks.

And we can look even longer – 20 years is a very long time, so let’s look at that.

11-12-2012 Listed Property index component charts 20 years

Only one company has been around for the full 20 years but you can see the massive destruction of capital that occurred during the GFC.

 Property investors generally received large lumps of income from these securities in the period leading up to the GFC but the hit to capital was so big that those higher incomes became far less appealing. 

Investing with “legacy” issues

The past is often not a good indicator of the future potential of an investment and yet the past is the only record that an investor can look at to see how a particular investment has weathered different economic, legislative or market conditions.

The point of this note is to suggest that any interpretation of past returns as a basis for drawing conclusions about future returns is a pathway fraught with traps and pitfalls for the unwary. Marketing hype from fund managers, super funds, and everyone else with a vested interest are likely to amplify those traps and pitfalls. There’s no reason why you cannot look at past returns and try to use them to determine various aspects of valuation, timing and momentum. Just don’t get too carried away with your own analysis – the future remains an unwritten unknown, and all outcomes are a measure of probability rather than finite yes/no or 10%/8% type thinking!

 

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