Real Estate Investor Magazine South Africa August 2015 | Page 63

Real Estate

FOREIGN

Investment Trusts
Superior and growing
dividends, even as rates rise
BY GRANT LOWTON

T

here are only two things in life which are certain
– death and taxes, with the odd exception such
as Greece where tax evasion is deemed by some
to be a national sport. Perhaps we should add a third
item to that list – interest rates in the United States
are going up.
The two most important aspects when valuing an
asset such as real estate are estimating future cash flow
streams, as well as deciding on the correct discount
rate to apply to these cash flows. Rates in the US have
served as the proxy for the global risk-free rate. Thus,
US rates form the basis for the discount rate for many
asset valuations. The implication of an increase in US
interest rates is therefore a decrease in the value of
most financial assets around the globe (assuming stable
cash flows, which is not always the case – more on this
shortly).
The implications of rising rates for yield-seeking
investors
At Reitway we believe that cash and bonds (fixed
interest investments) are a key component of a
diversified portfolio. Their capital preservation qualities
assist in mitigating portfolio risk. These attributes
are most valuable during times of financial distress.
The cost of the abovementioned capital preservation
qualities, though, is low yield.
Currently, a one-year deposit in the US yields in the
region of 1.25% at most. Further out on the maturity
curve, a five-year paper can currently earn you up to
2.25%. In South Africa, a one-year paper currently
earns you a yield of 6-7%, with a five-year paper
currently providing a yield of about 8%. Official SA
inflation has ranged mainly between 4.5% and 7% over
the last five years. Anecdotal evidence is that practical
or ‘real-world’ inflation is significantly higher than that.
These income yields are not very attractive to investors
in inflation-adjusted terms.
Alternatives to fixed interest investments?
www.reimag.co.za

Conventional wisdom states that the market prices of
Real Estate Investment Trusts (REITs) are negatively
impacted by rising interest rates. This seems logical if
we assume fairly stable REIT cash flows, akin to a fixed
interest investment. However, demand for real estate
increases in an environment of rising interest rates
underpinned by economic growth. Combined with the
constrained supply of real estate in some sectors, many
REITs are able to substantially increase their rental
income and distributions to investors over time.

“A one-year deposit in the
US yields in the region of
1.25% at most.”
At Reitway Global, we do not advocate for REITs
as a replacement for fixed interest investments, because
REITs may decrease their income distributions
during exceptionally stressful financial circumstances.
However, over time REITs provide superior and
growing dividends relative to cash and bonds. We
therefore think that REITs warrant a higher portfolio
allocation for investors seeking superior income
streams along with capital appreciation. Another vital
aspect is to diversify globally, without making the
mistake of concentrating too much of your portfolio in
South Africa or in other emerging markets.

RESOURCES
Reitway Global Property
AUGUST 2015