Round and round we go - My Say No 53

23-04-2016 17:36:28

It is that time in the cycle that Listed Property Trusts (LPT's) rear their ugly heads once more and encourage me to revisit the them.

Apparently, in the recent past, listed property trusts have outperformed shares in 4 of the last 5 years; a statistic I can't argue with. However, what I would argue with is the time frame, the benchmark used for shares and the yield trap.

The justifications from property advocates haven't changed over time and remain as misleading as usual. So, let's start with number one; the time frame.
LPT's were seriously damaged goods during the GFC as result of a prior massive increase in debt levels and poor corporate governance amongst other things.
Their resulting decline was substantially greater than other indices so using the low point after a huge fall as the starting point for the performance comparison with shares must be of concern.

As usual the benchmark for shares is the All Ords index, the favourite for all property comparisons as it contains a large element of resource stocks. Since the mining boom failure (which coincided with a sharp recovery in LPT's) we have seen this index severely compromised by the steep decline in resource share prices.

Comparing over 5 years one index that is declining sharply with one in recovery mode, from a discount to net tangible assets, seems moderately unfair!

For those familiar with my philosophy you will know my disdain for the All Ords as a measure of performance for any serious long term investor.

Below is a comparison of the 3 primary indices. As an investor I personally have never been happy with resources and thus have chosen the Industrials Index as my benchmark.
I cannot see why I should add resources to my portfolio to drag it back to the All Ords.

No doubt someone will say that 'actively' managing the portfolio enables you to access the best of both worlds!



Instead of the All Ords, if I pitch the results for property against industrial shares we have the following picture.




It will be apparent that over a more 'meaningful' time frame the result for shares is a far more attractive outcome. Let's face it, if one could make more money owning property than running a business, why would anyone bother to go into business.
Property is a deadweight on the balance sheet of a good company.

It has taken 200 years of European settlement for the penny to finally drop with company boards in Australia that it makes good commercial sense to get the property off the balance sheet and to lease premises.
Fortunately for them there is an unhealthy appetite amongst the unwary for the cast offs.
This brings me to the final concern I have; the yield trap. The high yielding property trusts have always been a favourite of those seeking income.
The chart below shows why; the yields from property have clearly exceeded those from industrial shares.




The reason for this is quite simple. Property trusts, as a result of their structure must distribute 100% of their income to avoid potential double taxation.
As a consequence, the vertical income bars (pink) in chart 2 above represent a 100% payout ratio.

In contrast to this, the vertical yellow bars represent around 50% of the profits generated by industry.
The corporate structure enables companies to retain profits without penalty for research and development, new technology etc.

The trap is baited by the fact that the yield is an abstract numeric (income divided by index value) that basically tells you where the value line in chart 2 lies in relation to the top of the dividend bars.
If dividends remain stable the simple numeric relationship means that if share prices fall the yields will rise; conversely, if share prices rise yields will fall.

It will be apparent from chart 2 that the high yield of property is simply a function of the fact that the capital value is well below the dividend bars. Similarly, the industrials are low yielding because the value line is much closer to the top of the dividend bars.

Now, try and imagine the yield on shares if all companies, like listed property trusts, paid out 100% of profits every year!

It is this sophistry that enabled a journalist to write an entire article on this topic back in September 2010. The article was titled, "Trust returns to listed property".
Look at chart 2 above (in particular the 2010 period) and then read the following quote.

"With a current average dividend yield of 5.7% property trusts have again become one of the most attractive sectors for income investors".

Can anyone tell me what person in their right mind would ever buy LPT's for income?

Forget yield; shares are income investments and, as I have highlighted in previous articles, the bulk of the return from INDUSTRIAL shares comes from dividends, not share price movements.

As a final comment, I mentioned above my disinterest in resource shares. It is worth noting that the industrials index above has the LPT index as an integral sector within it. As a simple investor, the two filters I apply are firstly, no resources and secondly, no property.

This has enabled me, over time, to comfortably outperform not only the listed property trusts and All Ords but also the industrials index.



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