Listed funds investors beware of REITS

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07 Aug 2013

Much has been said about the benefits of the new Real Estate Investment Trust (REIT) structure which has become available to the South African property sector.

Alexander explains that volatility is higher with listed property than a defensive or balanced portfolio, property yields are currently lower than bond yields making property more expensive but there is more risk associated with property, the Rand is a threat to our bond market and given the close correlation, the property market is also under threat from a weaker Rand, lower economic growth causes increased vacancies and rising operating costs will eat into profits.

Aimed at aligning the South African listed property sector with our international counterparts, REITs may create a more attractive investment structure, significantly enhancing international interest, while at the same time bringing about much-needed tax and regulatory changes that local property structures could certainly benefit from in the long term.

Grant Alexander, director of Private Client Holdings, warns that REITs might not offer investors as much as hoped and advises that real estate as an asset class holds several pitfalls which South African investors must be aware of.

The arguments in favour of listed property include diversification with strong, predictable returns when equities are weak, good yields compared to cash, benefits afforded in a low interest rate environment and being a good inflation hedge.

However, there are many arguments against listed property, says Alexander. 

Alexander explains that volatility is higher with listed property than a defensive or balanced portfolio, property yields are currently lower than bond yields making property more expensive but there is more risk associated with property,  the Rand is a threat to our bond market and given the close correlation, the property market is also under threat from a weaker Rand, lower economic growth causes increased vacancies and rising operating costs will eat into profits.

“Rising bond yields is the main threat to the sector – higher yields mean lower prices.”

According to Alexander, listed property has benefitted from strong retail performance – and many of the factors which have led to this strong performance, such as unsecured lending and salary increases ahead of inflation are unsustainable.

“If the retailers slow down the property sector will slow down as vacancies rise and retailers will start resisting annual rental escalations more.”

He says the introduction of REITs to South Africa will make real estate more attractive to foreign investors but it does not significantly change the SA property investment structure compared to the previous regime.

 “It is thought that one of the main benefits provided by the REIT structure is the tax change - SA investors will receive gross distributions from an SA REIT entity – without the 15 percent dividends withholdings tax being levied.” 

However, investors will have to pay tax on the distributions at their applicable marginal income tax rate – so paying tax is unavoidable, says Alexander.

Real Estate is a complicated asset class as one must consider many factors such as occupancy levels, yields and retail demand.

However, all of this being said – REITs are a good diversifier and should be held as part of a balanced portfolio, but if you intend to buy as your sole focus – Caveat Emptor, ‘let the buyer beware’, adds Alexander.

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