Investors across the globe have spent the past couple of years searching for yield in an investment environment where the sources of that yield are rapidly diminishing.
To minimise volatility and uncertainty, investors are increasingly looking to expensive equities, high-quality fixed income, multi-asset or alternative propositions.
We have identified property in Hong Kong as one specific opportunity that surprisingly provides a high, and in our view sustainable, dividend yield while remaining attractive in terms of valuations.
Pitching the cost
Property in Hong Kong has looked overvalued for the past two or three years at least. It is expensive and we think prices should probably come off by 20% but, from a stockpicker’s point of view, there are plenty of reasons to see property companies as a positive investment.
Most people recognise that property prices should correct across residential, office and commercial space. But for us, many of these options have been priced-in so that some stocks are trading at huge discounts to NAV, which from a valuation perspective, means they are pretty attractive.
For example, we look at a property developer’s ability to generate dividends rather than simply short-term development profits, which will surprise those who only see them as businesses that build or develop properties to sell on.
We view them differently from the usual equity investor as we are interested in whether they can pay a sustainable dividend. We look at this more like an income stream – which has the potential to increase the yield over time.
Unlike other property developers, these companies have strong, cash-rich balance sheets and have become very good at building recurrent revenue streams. However, most are not just developers as they generate perhaps 30-40% of their income from office rental and retail space. The ones we like are increasing their recurrent revenue by developing the blocks they build in Hong Kong, the Philippines and China. They will build then sell the apartment blocks but keep some of the space themselves as a retail mall or serviced apartments, which is where they derive their recurrent income. In this scenario property prices do not have to go up for those property stocks to do well.
Big yield potential
What adds to their attraction is the current, almost extreme, search for yield? You can borrow money for virtually nothing. We are seeing big privatisations, share buybacks and so on, yet there are still stocks, such as Hopewell Holdings, New World Development and Sun Hung Kai Properties (SHKP) – all Hong Kong-based – currently throwing off a 4.5-5% yield. What would bond investors do for a crystallised 5% recurrent yield right now?
To illustrate this further, a Morgan Stanley research report (July 2016) expects SHKP’s underlying profit to grow 20% year on year by the end of 2016; dividends per share are expected to grow 10% year on year (implying a 45% pay-out ratio); and, residential sales are predicted to nearly triple.
While all these developers have projects on the go, New World Development has one that is due to complete in 2019, at which point its asset value could increase by 10% while its recurrent income could jump by 20%. It is not just a short-term opportunity either.
We have owned some of these stocks as part of our New Capital Asia Pacific Equity Income Fund since close to launch more than five years ago.
Interest rate risk?
Looking elsewhere, it is not just the property developers seeing the value in Asian property, with insurance companies across mainland China among those also buying up office towers. They are prepared to pay more because what they are really buying is the yield that bricks and mortar provides. The obvious danger is rising interest rates but any significant rise seems unlikely in the current environment.
In a world where sustainable income is increasingly difficult to find while investors’ demand for yield is on the rise, Hong Kong property appears to offer plenty of opportunities to satisfy both.
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