If youve ever perused the Johannesburg Stock Exchange share pages in search of potential shares and happened on the property section, youll have noticed that there are three separate sectors listed there: property companies, property trusts and property loan stocks.
One of the least talked about and underrated of the three is the property loan stock sector, which is currently offering exceptional value, at least according to some property analysts.
If youre wondering what exactly a property loan stock company is, youre not alone. However, its exotic name hides a very basic activity, which is investment in different property portfolios.
Where property loan stock companies differ from other companies is in the way they are capitalised. While traditional companies are capitalised by owners putting up cash, property loan stocks are capitalised mainly by loans up to 99% of the capital of a company is derived from loans.
Take a deep breath; heres where it gets tricky. Because the loan stock company is capitalised 99% by loans and only 1% by owners shares, when it comes to rewarding investors, it pays out interest on the 99% loaned and a dividend on the 1% of share capital. This payment is called a distribution.
Remember that, unlike dividends, any investment that earns interest is taxable in your own hands. So if you invest in a loan stock company, be prepared for the tax implications.
According to Allan Gray property analyst Mariette Warner, the property loan stock sectors price performance is closely linked to the interest rate environment of the day: the higher the interest rate, the cheaper the sector. In the current environment of climbing rates, this means that prices of the sectors stock are effectively falling. If you look at the underlying value of the companies portfolios, youll see at the moment that these exceed their ruling share prices by an average of 20% to 30%.
She says a handy benchmark of whether or not a particular property loan stock company offers good value is to look at what is commonly known as the yield effectively the distribution yield.
The average for the sector currently stands at around 17%. A company whose yield is in excess of 20% probably doesnt offer all that much in terms of earnings growth potential, she says, meaning that it is reasonably priced relative to the sector. However, companies with yields of less than 20% might have a better chance of showing earnings and distribution growth, Warner says.
Currently Hyprop, at a yield of about 14%, and KH Props, at 14,8%, are good examples of these and compare with companies like Compass at 22,4%, Norvest at 21,5% and Octodec at 21,9%. That doesnt mean there arent dud portfolios among companies showing yields below the average and some good investments with yields in excess of 20%.
According to Warner, when determining whether or not a loan stock offers good value or the potential for robust future growth, its important to look at the underlying quality of their respective property portfolios.
The Norvest portfolio, for example, mostly consists of older buildings in low-growth areas, where the prospects for property prices are not very good. On the other hand, the portfolios held by KH Props and Hyprop are considered to be of good quality, with lower risk and strong earnings potential.
If you have a good gut feeling about the potential of the local property market, its clear that an investment in the property loan stock sector at this time might ensure a cheap entry into a future growth sector.
For those who are concerned about the general trend among institutional investors to reduce their investment in property a factor which has also undermined the sectors growth there is some reassurance in the cyclical nature of investment this trend is unlikely to continue indefinitely.
According to Warner, if market volatility makes equity investment an increasingly unpopular option, the return to investment in property might well be sooner than expected.