Capitalisation rates and property yields in the South African property sector

To analyse and interpret the movement in commercial property values a number of different performance measures can be used, including capitalisation rates and property yields. In South Africa, the former measure is traditionally an important benchmark for local institutional investors who still dominate the direct property market, whereas the latter is a popular measure used in the indirect property market, such as for listed property unit trusts (comparable to REITS in the USA). Examining capitalisation rate and property yield patterns of commercial properties during the past decade, notable differences come to the fore. Capitalisation rates are considerably lower and less volatile than property yields. These differences have important implications, since lower rates/yields imply higher property values. Globally, there has been a reduced exposure by institutional investors to (illiquid) direct properties and a concomitant increase in indirect property ownership in the form of (liquid) listed securities. This change has enhanced the interest in and stature of commercial properties as an alternative investment class. In the process, listed property securities inevitably start demonstrating attributes more akin to equity stocks and lose the ëperformance-smoothingí attributes typically associated with direct property investment portfolios. To follow the trend towards ownership of listed property securities successfully in South Africa, it is imperative that the differential between capitalisation rates and property yields is diminished in order to entice institutional investors to off-load their direct property holdings. In the paper the relationship between capitalisation rates and property yields in the capital market is explored. As performance measures, capitalisation rates and property yields are defined, and their essential nature is discussed. This is followed by an analysis of their historical patterns. An attempt is made to explain and to reconcile quantitative differences between the two measures. Based on this, prospects for and implications of a better linkage between the two measures in the South African commercial property market are considered.