Storm Clouds over Residential Property

Property is the only investment where even stupid people can make money. That’s the view of South African-born billionaire Nathan (“Natie”) Kirsh, who has amassed a real-estate empire worth billions, which spans the US, the UK, South Africa and Australia. He featured in the Top 20 in the 2015 London Sunday Times Rich List, for being worth about R91bn.

While Kirsh’s self-effacing humour makes for great media coverage, what it fails to capture is that property – just like any other asset class – is also a good way for people to lose money.

“Property cycles come and go – years of feast are typically followed by years of famine,” says Adrian Goslett, CEO of RE/MAX Southern Africa. “The residential market is probably at a crossroads right now. While I don’t think we’ll see a massive price correction, we’re probably due for a growth correction.”

Residential property has certainly had a good run over the last decade-and-a-half. FNB’s Property Barometer shows that South African house prices surged a massive 280.9% in nominal terms between January 2001 and July 2015. Even when adjusting for inflation, the average real house price in South Africa is still 66.3% above what it was in January 2001.

 

SHIFTING PATTERNS OF RETURN

That’s precisely what makes residential property South Africa’s favourite asset class. Virtually everyone, regardless of race, class, income or social background, aspires to own their own home. But while the residential market has offered stellar returns when measured from January 2001 to July 2015, a closer inspection reveals that the weather is beginning to change.

According to FNB’s data, once inflation is taken into account, the average real house price in South Africa is almost 19% lower than the high reached in December 2007.

Property economist Erwin Rode, CEO of Rode & Associates, is not surprised. “Property is a function of the South African economy, which is a function of global economic forces,” he says. “South Africa’s economy has not really performed that well since the financial crisis, and at the moment the outlook is bleak.”

That’s why Rode, for at least the last four years, has been advising people to rent rather than buy. In fact, Rode says the only reason one should buy a house in the current market is if you are able to do so with a 100% cash purchase. “Over the next five years, the prognosis for the economy is poor and therefore the outlook for property is also poor,” says Rode.

Another potential spanner in the works for property is the interest-rate outlook. The South African Reserve Bank has been at pains to warn consumers that it intends to normalise interest rates, which fell to multi-decade lows in the wake of the 2008 financial crisis. Although the central bank paused at its September policy meeting – so as not to imperil the economy, which shrank 1.3% in the second quarter – consumers need to brace for higher borrowing costs going forward.

“Rates must go up. The only question is how fast and by how much,” says Rode. “Once the US Federal Reserve System begins its own tightening cycle, the Reserve Bank will have no choice but to hike rates.”

 

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THE STORM AHEAD

Rode’s forecast is for two percentage points of increases over the next two years. FNB property economist John Loos agrees that interest rates are likely to rise, but says it will be gradual. He is forecasting a one percentage point rate increase by early 2017.

Loos is also similarly downbeat on the long-term prospects for property. “Current property prices still reflect the buoyant times when the economy was growing at more than 5%,” he says. “Given the challenges facing the economy – which range from an electricity shortage, slow growth, labour issues and a possible ratings downgrade – we’ll be lucky if we get growth of between 1% and 2%. In that scenario, we are likely to see a downward real price correction in the residential property market over the next five years and maybe even for as long as 10 years.”

Loos says it’s impossible to quantify just how much property prices will correct, but he reiterates that right now doesn’t present the best buying opportunity. So what is the prospective home buyer likely to do?

 

A SILVER LINING?

Both Loos and Rode stress that their forecast is for the market as a whole. Certain sub-sectors of the market may still offer opportunities. Moreover, there are important caveats that can impact an individual’s purchasing decision.

“People don’t only buy for pure investment reasons,” says Rode. “They also buy for practical, emotional and social reasons. If your partner is tired of living in a rented flat, you’re more likely to consider buying a house despite the market outlook.”

Location is also a key factor. Rode says places with limited land for development, such as Cape Town’s CBD and Atlantic Seaboard or the Sandton CBD, are likely to continue outperforming the general market. Suburbs that are key catchment areas for sought-after schools, such as Cape Town’s Southern Suburbs, will also continue to enjoy a buffer against negative factors affecting the general market.

“There are micro-pockets within the property market that could still do well,” agrees Goslett. “Any area that is close to good schools, and primary schools in particular, will continue to experience robust demand. Areas such as the Cape Town and Sandton CBDs – and even once obscure places like Lephalale, where the Medupi Power Station is being built – continue to experience good rental growth.”

Says Andrew Golding, chief executive of Pam Golding Property Group: “Despite a current gloomy economic environment, the residential housing sector has been in surprisingly positive territory. Demand continues to outstrip supply.”

Samuel Seeff, chairman of Seeff Properties is a little more circumspect. While he remains cautiously optimistic that residential property growth will at least match inflation or even marginally outstrip inflation in the foreseeable future, he concedes that economic headwinds could be a drag on the market. “Nonetheless, we believe that the still tight stock levels should keep the market nicely balanced into next year.”

A new force that is starting to shape the face of property is the rising cost of ownership. Rising electricity, water, rates, security and maintenance costs are already resulting in a preference for smaller, lock-up-and-go homes. Loos says the vast array of consumer goods that didn’t exist in previous eras, but which consumers now regard as necessities (think internet, tablets, smartphones) also leave less disposable income available for property purchases.

“Not only was the cost of ownership lower in previous eras, there just wasn’t as much stuff to buy. People could apportion a greater chunk of their incomes towards paying off their homes,” says Loos. “If the past was characterised by large houses with sprawling lawns, pools and double garages, then the future will have smaller homes with a lot more consumer goods packed into them.”

 

KEEPING AHEAD

Our immediate economic future is being described as a period of high inflation and low growth. There are valid reasons for this but many of them are out of the control of the real estate industry. So how do we prepare?

Three things are critical: access to credit, managing consumer expectations and strong marketing plans.

It seems that SA’s major banks have adjusted to the tough economic conditions and are in a cycle to compete with one another for market share. So credit, at least for the short term, is flowing into the market. Identifying the best consumers, early in the buying process is key. Originators will play an important role here.

Agents need to set realistic expectations with sellers on price and time on market. Now’s not the time to speculate with over-priced properties.

A strong marketing plan is a must in a down market. Agents need to build a strategy with the sellers: how much should we ask, when is the best time to market, how do we utilise marketing platforms…Great photos, detailed descriptions and a strong sales follow up are essential.

– SIMON BRAY, CEO, PRIVATE PROPERTY

 

THEN AND NOW, IN NUMBERS

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Words: Garth Theunissen

 

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