INVESTING
31 July 2019
Becoming a commercial property value investor
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ow is the perfect opportunity to become a value investor in commercial and industrial property and to ditch the generalist market investor approach. This is according to Tony Bales of industrial property broker, Epping Property. “For the past few years, most physical industrial and commercial properties have shown good capital appreciation and income returns, and many investors took to purchasing any available commercial or industrial property.” However, this will not be the case moving forward. Enter the age of value investing The market has changed. Wise investors are seeking out properties in specific locations with specific fundamentals – properties that offer an investment that will grow at an above average rate. Enter the age of value investing. Bales explains that value investing is investing in a property that has been undervalued or where one can purchase the property at a below-market price. “The specific benefits are an above-market appreciation in either the capital value or rental income, or both. In a sophisticated market, finding properties that offer value may involve sifting through a lot of various opportunities.” Bales further advises that what is value for one investor may not be value for another. “For example, a passive investor may offload a property to one who has the capacity, time and inclination to develop it and unlock the potential value. Investors all have different profiles, such as knowledge, capacity, skills, etc, thus ensuring constant value arbitrage in the commercial and industrial property market.“It is also important to distinguish between the listed property sector and investing directly in physical property. Unfortunately, the listed property sector has had a torrid last 18 months. Investing in listed shares is different from investing in specific physical properties. It is vitally important to understand what the drivers of the listed property sector are versus the drivers of physical commercial and industrial property. Value investing in the listed property sector is different from value investing in specific properties.” How does an individual investor go about determining what is an appropriate ‘value purchase’? Bales says that firstly one needs to understand the difference between price and value. “Price is what one pays, while value is what one receives. This may sound like a simple statement, but it’s implications run deep. Buying investment property at too high a price isn’t good value and is the surest way to limit future returns. However, commercial property can double or triple in value for an investor who can spot hidden growth potential, develop a strategy to unlock that untapped value, and execute that plan.” Bales provides a list of questions that buyers should ask themselves: • Do I have an excellent understanding of the property I wish to buy? • Does the purchase price offer upside potential? • What is it about this property that will ensure its value grows faster than other properties? • What do I need to do to ensure this potential value is unlocked as soon as possible? “The highest returns come from buying commercial investment property at a price that doesn’t reflect its inherent attributes. Value investors follow strategies to find, and mine, those features. The key here,” says Bales, “is to understand exactly what is value for oneself. The greatest value investor of all time, Warren Buffett, did not buy any technology shares during the boom in the late 1990s – a move for which he faced major criticism. However, his actions were well rewarded in the end as today he is one of the wealthiest people in the world. And he has now included tech shares in his investment portfolio.” Value has no borders According to Bales, another aspect to understand is that of internationalisation. “Investors must see the value concept as one that has no borders. What may seem overpriced to South Africans might be value for international players due to the higher yields. Conversely, when the US dollar strengthens, we must expect the SA property market to offer less value than more developed countries, and hence investors will move funds to those countries that offer them more perceived value. It’s simple. We are part of the international economy and cannot ignore the fact – it affects our commercial and industrial property market and the concept of value.”
The ethics of short selling
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he Financial Sector Conduct Authority’s (FSCA’s) short sale reporting and disclosure framework, proposed earlier this year, has been met with reservation by the JSE for a number of reasons. While the proposal is intended to tighten the regulations around short selling in South Africa, it is important to note that it is a few of the practitioners, rather than the practice, of short selling that can be unethical. This is according to Jessica Ground, the Head of Sustainability at Schroders, who acknowledges that on the face of it, an investment strategy specifically designed to gain in value when companies fall in value may seem irresponsible. “While it undeniably has its more unsavoury side, short selling can also help manage risk more effectively and contribute to market efficiency. Its reputation is unfairly tarnished by the actions of a few cowboys.” Ground says that, in practical terms, short selling involves borrowing a stock from an investor, and then immediately selling it in the hope that its price will fall and it can be bought back later at a cheaper price. “A profit is realised based on the price decline. At that stage it is returned to the original shareholder, who receives a fee for their troubles. “It is only when investors take additional steps to influence companies’ financial health and value after they have bought or sold shares that ethical questions arise,” she explains. As such, to assess the ethics of short selling, Ground believes it is important to consider the actions of different short sellers, rather than short selling as a principle. “In general, those actions reflect their motivations, which can be broadly split into four categories, namely: ‘stock picking on steroids’, the ‘activist shorter’, the ‘risk manager’, and the ‘emotionallydetached trend follower’.” The “stock picker on steroids”, Ground says, is very similar to traditional “long-only” investors, in that they both try to identify undervalued stocks, in the expectation that their value will converge on some estimate of fair value. “The difference between the two, however, is that the short seller will search for overvalued stocks or stocks that are facing structural headwinds that are not yet fully reflected in the price.” The “activist shorter”, on the other hand, takes a more extreme approach than the “stock picker on steroids”,
she adds. “Rather than assuming that the market will eventually price companies fairly, the activist shorter seeks to force the issue. “However, the more extreme activist shorters are the ones that give the practice a bad name. Some have been guilty of spreading unfounded and malicious rumours in the press – a consequence of which is that they can earn a profit on their trade but push otherwise healthy companies into financial difficulties. Even if these companies manage to prove the accusations false, the short seller may be long gone by that stage, having booked a profit on their trade and left a trail of devastation in their wake,” says Ground. Then there are the “risk managers”, who use shorting to control risk in their portfolios and express their views on particular stocks in as pure a way as possible. “Shorting allows a cleaner expression of a view on a particular stock or sector while also reducing volatility and risk of loss. The approach does not affect the health of individual companies, is typically low profile and doesn’t raise ethical concerns in our view.” Lastly, Ground refers to the “emotionally-detached trend follower”, who seeks to profit from trends in markets; buying when markets are rising and shorting when they are falling. “These shorters employ strategies that are normally highly quantitative and systematic in nature, powered by powerful computer algorithms. “Their emotionally detached nature means they cannot be accused of attempting to drive down prices. It is all about mathematics,” she highlights. Considering this, Ground believes that short selling may have an unfairly bad reputation. “Rather than avoiding the practice, investors – especially those who are more ethically minded – may wish to ensure they understand its potential uses in a strategy and how its practitioners intend to behave. “It can bring about significant benefits, both to investment performance and standards of corporate governance. Although some short sellers are unethical, short selling itself is not.”
Jessica Ground, Head: Sustainability, Schroders
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