SA Property Review – Investing in South African Residential Property

Levels of activity and price growth in the South African residential property market have slowed down considerably over the past year on the back of sharply rising inflation, which caused interest rates to have been hiked by a cumulative 500 basis points since June 2006; the full implementation of the National Credit Act about a year ago; and the recent tightening of credit criteria by some banks. In view of the impact of these developments on the property market, many people, including homeowners and prospective homebuyers, have become uncertain whether residential property can still be regarded as a sound investment.

An important consideration with regard to any investment is the return (a regular income and/or a capital gain after taking into account the effect of inflation). Although nominal house prices in the middle segment of the market (houses of 80 m² - 400 m², up to R2,9 million) have increased by about 12% per annum over the past twenty years, real prices have risen by only about 4% per annum over this period, mainly as a result of high levels of inflation at certain stages during this period (see table). Over the past few years since the property market recovered in 2000 after a long period of mediocre performance, house prices have surged by about 19% per annum in nominal terms, while in real terms, prices have risen by around 13% per annum. The past eight years since 2000 were marked by significantly lower inflation compared with the 1980s and 1990s.

Residential property has performed particularly well in comparison with other asset classes over the past number of years, based on the gross internal rate of return (IRR), which excludes deductions for maintenance costs, commissions and rates and taxes. The IRR includes the capital appreciation as well as the income that can be derived from the asset. Over periods of five, ten, fifteen and twenty years, an investment in residential property in South Africa has beaten most other asset classes, as well as inflation (see table and graph on the IRR by asset class). This only applies to the situation where a house is rented in order to earn an income.

Based on the latest trends in house prices, as measured by the monthly Absa House Price Index (see graph on house price trends), property owners who bought a house during the past year, are not expected to realise a sizable profit in nominal terms, if any at all, if they decide to sell now. In June 2008, nominal house prices were up by just 3,8% compared with June last year, with virtually no growth recorded since the beginning of 2008. In real terms, property prices have already declined since late last year, which implies that, on average, a property owner who has bought property during the past two years, is set to make no profit, or even a loss, if he sells now. However, property owners who have bought 5 or 10 years ago, will probably still realise an acceptable capital gain in both nominal and real terms if they sell their properties today, although profits may now be somewhat less than what they would have been had they sold their properties a year or two ago (see table and graph on nominal and real house price trends).

On the back of the current as well as expected economic conditions over the next 12 to 18 months, nominal house price growth is expected to slow down to a level of about 5% in 2008 and 4% in 2009. In real terms, however, house prices are forecast to drop by around 6% in 2008 and another 3,3% in 2009. With the residential property market expected to slow down further towards the end of 2008, bottoming in 2009, it will in the second half of this year and in 2009 be the time to buy property, especially from an investment and buy-to-let/rental point of view. Investors in the residential property market should not expect to achieve positive real capital appreciation during the next 18 to 24 months, but with an increase in demand for rental property, an acceptable income return may be achieved during this period. In view of property being a medium to longer-term investment (5 years and longer), property investors should look through the current downward cycle and focus on income returns, with a view of achieving positive real capital appreciation from 2010.

Economic conditions are expected to improve from late 2009 on the back of declining inflation, translating in interest rates currently forecast to drop to 14% by end-2009, and declining to 12,5% in the period 2010-2012. On the back of these developments, nominal house prices are projected to rise by 10,8% in 2010, 12,1% in 2011 and 12,7% in 2012. In real terms, price growth of 5,1% is forecast for 2010, rising to 6,5% in 2011 and 7,1% in 2012.

Against the background of the abovementioned trends and expectations regarding the South African housing market, an investment in property should always take account of the following factors:

• Property is a medium to long-term investment (ideally 5 years and longer).
• The stance of and prospects for the most important external factors impacting the property market (environment, society, legislation, economy, technology, infrastructure).
• The stance of and prospects for the property cycle taking into account the broader business cycle (inflation, interest rates, economic growth, etc), as this can have an influence on capital appreciation and rental yields.
• The purpose of an investment in property (for instance primary use, buy-to-let/rental, speculation and/or asset diversification).
• Specific regional, neighbourhood, sectoral and economic infrastructure (roads, railways, etc) trends, developments and factors which are having or could have an impact on future values and returns.
• Diversification of a property portfolio (the type of property, such as vacant land, residential, commercial or industrial; area, such as inland, coastal, rural or urban; and type of investment, such as direct, fractional ownership and listed property (a managed portfolio of properties)).
• Liquidity (shares, unit trusts and listed property are more liquid than direct property investments, but may carry a higher risk).
• Buying new (buying off plan) versus buying existing property, or building, taking into account various aspects related to these ways of acquiring property.
• Location is probably still one of the most important considerations when buying property.
• Tax implications (capital gains tax, personal income tax and estate duty).
• Costs (transaction costs, such as transfer duty, conveyancing fees, commissions, rates and taxes, maintenance and letting costs).

Taking account of all the relevant developments, trends and factors having an impact on the property market and its performance, property should remain a good investment in future.

Courtesy Jacques du Toit Senior Economist ABSA Bank

Explanatory Notes:

The Absa House Price Index is based on the total purchase price of houses in the 80m2 – 400m2 size category, valued at R2,9 million or less in 2007 (including improvements), in respect of which loan application were approved by Absa. Prices are smoothed in an attempt to exclude the distorting effect of seasonal factors and outliers in the data. As a result, the most recent index figures may differ materially from previously published figures.

Disclaimer:

The information in this publication is derived from sources which are regarded as accurate and reliable, is of a general nature only, does not constitute advice and may not be applicable to all circumstances. Detailed advice should be obtained in individual cases. No responsibility for any error, omission or loss sustained by any person acting or refraining from acting as a result of this publication is accepted by Absa Group Limited and/or the authors of the material.