sector faces threat of being left behind should market rotate to favour growth over value
While property as an asset class continues to offer a low-risk income stream, property shares seem set for continued volatility.
Perceived as a defensive investment, there is a significant threat property shares could be left behind if the equity market moves to favour growth plays, according to William Hemmings, manager of the Aberdeen Property Share fund.
As a result, Aberdeen has a house view of neutral on the sector. Hemmings said: 'If the equity market should run ahead strongly, property shares are likely to be left behind. Nevertheless, in this kind of scenario, concerns over rents and take-up of space are likely to subside. Should rates stay low and discounts remain wide, there is also the likelihood of a pick-up in corporate activity.'
Because of this, Aberdeen believes the valuations given to property shares by the market seem overly cautious. Hemmings added: 'The rate of decline in the direct property market has slowed and, assuming there is not a collapse in rents, the discounts on which property shares are presently trading appear overly cautious.'
Hemmings said investors should not view property share volatility as a bad thing, as the asset class provides diversification when growth-oriented equities are falling. The IMA property share sector, in which funds must invest at least 80% in property shares, contains only two members ' the Aberdeen Property Share fund and the Norwich Property fund, managed by Geraldine Davies.
The Aberdeen portfolio has returned 10% for the three months to 8 April 2002 on a bid-to-bid basis and 35.1% over three years to the same date on an offer-to-bid basis.
By contrast, the Norwich fund has returned 3% over the three-month period and 23.2% over the three-year period.
Davies said the Norwich Union forecast for the direct property market total return is around 7.5% for 2002 and 9% per year over the next three years.
She added: 'The majority of this return is accounted for by the income return, with underlying values likely to remain stable and rental growth fairly subdued.'
Hemmings said: 'Unlike the recession of the early 1990s, where speculative development by highly leveraged companies led to an immediate oversupply of new space at reduced rates, speculative development this year has been limited. The only significant source of oversupply at present is space available for sub-letting.'
Hemmings feels even this is not satisfactory. He said: 'The bulk of this space is of secondary quality and only offered on short-lease terms. Accordingly, there is pressure on rents and any economic pick-up is likely to see such space being rapidly removed from the letting market.'
According to Hemmings, pension funds are increasingly seeking secure sources of yield to allow them to match their future liabilities.
He added: 'With pension funds having significantly reduced their property weightings over the past 20 years, there is scope for an increase in weighting, particularly given the bond-like income of direct property.'
Davies said: 'Property company share prices are likely to remain volatile as the equity markets remain undecided on the defensive versus cyclical nature of certain stocks. Bid speculation and corporate restructures are likely to be among the principle drivers in value of certain stocks comprising the sector.'
The best-performing stocks in Davies' portfolio during March include Chelsfield, which has returned 12.2%, NHP, which returned 6.87%, and Slough Estates, which returned 6.85%.
She has recently reduced her cash weighting to 9%, with the direct investment weighting now standing at 73.2% and the indirect or property-related assets weighting at 17.8%.
Hemmings' top ten holdings include a 4.5% weighting in Ashtenne Holdings, which acquires and manages industrial estates and property, including 169 estates in Scotland, South East Wales and North East England.
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