The SA residential property sector – market reflections and forecasts
After a massive house price boom during the first half of the new millennium, one could be forgiven for believing that it was a ‘once in a lifetime phenomenon’ never to be repeated in our lifetime. And, yes, realistically, the pace of house price inflation that was achieved over those years will be difficult to repeat any time soon. Using the Absa House Price Index, from the end of 1999 until the end of 2005, cumulative house price inflation was 208.5%. By 2006, it appeared to have been generally accepted that the house price boom was over. But was it?
Admittedly, average house price inflation of 15.3% in 2006 was down on the 32% and 23.2% averages for 2004 and 2005 respectively, but nevertheless the rate remained very respectable. Furthermore, it was well above the average consumer price inflation rate of 4.6%, implying a strong rate of real house price growth. Perhaps a better term for this slowdown in the housing market would be ‘slowdown in the boom’, or ‘moving from the sprint to the marathon’. And the marathon could last into the next decade.
What keeps me bullish regarding the rest of the decade’s housing market performance? One simple word: scarcity. Whereas new house price inflation was predominantly ‘demand-pull’ inflation during the main boom years, it would appear to be starting to revert to ‘cost-push’ inflation, and that ‘cost-push’ is becoming very strong. We are currently witnessing a sharp rise in building costs. While demand for residential units is currently in a short term lull, a number of other sectors are placing huge demands on the construction sector at present.
Real construction sector value added grew at a rapid 13.3%, the combination of residential building activity, increasing commercial property building activity and government infrastructure projects, and the early stages of 2010 preparations. The result? Increasing skills and materials scarcity, and sharply rising building cost inflation.
With commercial property vacancies having declined sharply over a few years, a frantic pace of development of new space will be required to match demand, and with commercial property returns very impressive, the residential property sector will have its work cut out in competing for many of the scarce resources needed for new development. This is expected to play a key role in limiting the growth in supply of new residential stock. But a sharp rise in building cost inflation over the next few years is only half the story. The other half is demand. Real economic growth appears to have shifted up a gear in recent years, into the 4-5% range. Solid economic growth by SA’s historic standards implies more rapid growth of household disposable income, and in middle class numbers, and all this leads to more rapid growth in housing demand. More rapid economic growth also places huge demands on infrastructure, which is the reason why the construction sector is booming the way it is.
Over the rest of the decade, it is this combination of more rapid housing demand growth coupled with sharply rising building cost inflation and limits on growth in new housing stock that is key to a relatively bullish picture on the housing market. It will be a different kind of growth to the boom years that have passed and a little less extreme. Whereas the main boom years were driven by extreme demand growth as a result of interest rates dropping from a peak of 25.5% prime late in 1998 to 10.5% by 2005, an expected strengthening from 2008 (i.e. accelerating house price inflation) will be driven more by the combination of solid economic growth and growing constraints in housing supply, with interest rate reductions being very small in magnitude and thus playing a small role.
The impact of the 2010 World Cup soccer tournament will be experienced via the further pressure that it exerts on the construction sector. Hundreds of billions of rands worth of stadiums and related infrastructure and other massive public sector infrastructural investments will need to be built over the next few years. Furthermore, certain government-led infrastructure projects that would have taken place regardless of 2010 will be fast tracked for completion for 2010, either because they are required for the event or because of the positive impact they may have on the country’s image, creating a further construction industry supply crunch.
The final source of upward pressure on house prices will come from increasing land scarcity around major metropolitan areas. Not only are metropole councils beginning to place limits on unbridled urban sprawl, but the authorities are also unintentionally restricting urban sprawl by being unable to keep up with the demand for new infrastructure, the most important being transport infrastructure. Increasing traffic congestion accompanied by limited new road development makes it tough to just develop new residential property further and further away from business nodes. This is why an area like Sandton in Gauteng will have housing prices that will soar in years to come as traffic congestion gets worse and many high-income earners try to live closer and closer to work. Top quality schools will become key drivers of house price inflation, as many choose to live in the vicinity so as to avoid a one-hour commute in each direction merely to drop their children off. Then there will be another group ‘fleeing’ the chaos of the cities to smaller towns not too far away, driving those prices higher too. 2007 is expected to yield slightly lower average house price inflation than 2006. However, thereafter, the combination of solid demand growth along with mounting land and construction supply constraints, caused by more impressive economic growth than we’ve had in decades, is expected to drive it higher. This implies solid real house price inflation over the entire decade.
Hundreds of billions of rands worth of stadiums and related infrastructure and other massive public sector infrastructural investments will need to be built over the next few years.
Residential investment, especially in the buy-to-let sector, tends to be focused on capital growth while managing an income stream based on short-term leases. Investors should, however, look at the total returns – income and capital growth. A sustainable investment should therefore ideally be based within a commutable distance of a town or one of South Africa’s metropoles with a buoyant economy, where tenant and owner-occupier demand is likely to stay strong. Our internal statistics show that the average residential portfolio contains 5.7 properties and that most landlords take a long-term perspective – two out of three plan to hold onto their investments for more than 5 years. Residential property investments are anticipated to be held on average for 17 years, and such is the level of faith in the sector as an asset class in its own right that almost nine out of 10 investors say they would not sell their properties should house prices fall. Recent research has shown that the gross average weighted rental return on flats rose from 5.2% to 5.3% between the first and second quarters of this year, while on houses it grew from 4.9% to 5.1%.
DO YOUR HOMEWORK
If you are considering making an investment in residential property, make sure you research the local market. Look at the regional economic statistics available from building societies and from the Office for National Statistics. Consider the local average wage, and who will be likely to occupy the property. Weigh the return you are being offered against the risk, remembering that as the owner you will be responsible for all repair work. Bear in mind that the rental yields available in the residential sector mask hidden costs, such as managing agents’ fees, service charges, accountants’ fees and local council tax if the property is empty. Do your research and take professional advice. Assess your risk of not being able to make these payments if the unit is vacant and no rent is received.
Consider whether you want to invest in newlybuilt or second hand property, and look out for areas – such as Nelspruit – where the generation of employment and retail sectors may make the residential sector boom. Many private investors begin their portfolio with residential investments because they are a known quantity and the risks and capital required are generally lower. You will nearly always let a property eventually, even though there may be vacant periods. However, tenant turnover is much more frequent than in the commercial sector. A way of introducing a little commercial exposure into a residential portfolio is to invest in mixed-use property, such as shops with flats above. This offers an opportunity to experience the growth potential in both the commercial and residential sectors.
John Loos, Property strategist, FNB
“Information courtesy of the Alliance Group Property Investor Guide, available at all Alliance Group offices nationwide. To find out more, call 0861 ALLIANCE, or visit www.alliancegroup.co.za to download an electronic version“