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What to do with property?

What to do with property?

Great opportunity for tenants to buy property

By Andró Griessel

18 July 2020

The prime lending rate has been reduced to 7.25% on 22 May – the lowest it’s been in 50 years! This has been done in an effort to uphold an economy, which is hanging by a thread like a beat-up boxer, to prevent it from collapsing.

The significant reductions in interest rates over the past two years are a worldwide phenomenon that has been the tailwinds of a variety of asset classes. However, if we look at the performance of South African residential property over the past decade, the impact of this is not clear.

By making use of the analysis program, Lightstone, I have had a look at the performance of some of the bigger towns and cities (total of 34) in South Africa over the past decade. As with any set of data, more than one conclusion can be made by looking at the same information. Therefore, please take my conclusions with your own pinch of salt.

My observations: (2010 to 2020):

  • Inflation over the past 10 years = 5.16%
  • Total growth in median price = 71%
  • Growth in median price per year = 5.5%
  • Even though there have been some outliers on both sides, the property valuations of most towns have grown by between 4% and 7% per annum.

My interpretation

  • At first glance it looks as if property valuations have kept up with inflation, but unfortunately this is not the case. Property valuations are highly influenced by the affordability of loans.

If we take into account that the prime lending rate was 10% in 2010 and that inflation (therefore also the average salary increase) has been roughly 5.16% per annum since 2010, someone who could afford to pay R20 000 per month mortgage payment, would have been able to apply for a mortgage of R2 072 492 in 2010.

That same person, given inflationary salary increases and the decrease in interest rates, would now be able to afford a mortgage of R4 185 063. This represents a total increase of 102% compared to the 71% by which the median price has increased. It suggests that the “average” person’s property has declined by roughly 30% in real terms.

  • You would expect a return that is above inflation from property because property gets older and because maintenance costs need to be considered, which lowers the realized return in real terms.
  • I have mainly looked at larger towns (where economic activities and income are higher). I would therefore expect that if you were to do the same calculations for the country (and for every “Putsonderwater”-town), the numbers would look even worse.
  • There is a general assumption that “cheap” property can grow faster than property that is already more expensive. I was not able to confirm this assumption by looking at the information at my disposal. Within the towns that I looked at; the best growth came from properties that were already expensive.
  • Despite the low capital growth, property investments would in many cases still make sense because of the fact that a rental element is added. The return therefore does not only consist of capital growth, but also out of income return. In many cases (mostly with cheap property) rental income is a high percentage of the original buying price of a property. There are therefore still many investors who are able to invest in property with small deposits and where there are tenants who are able to help with the bond repayment.

At first glance this all looks very simple, but these investors should remember that a) for a long period of time, the rental income only covers the interest component of the bond repayment and not so much the capital component and b) in the absence of capital growth, the real value added using this strategy is questionably low over the longer term.

I have seen this approach go wrong when the location in which the property is situated is deteriorating, which leads to capital losses.

  • The abovementioned numbers do not take frictional costs such as commission, transfer costs and deeds office fees into account, which lowers the actual returns even more.
  • Initial valuations in 2010 could have been above average following a property bull market during the mid-2000’s, which had an impact on the ten year return numbers, but I am of the opinion that initial valuations in 2010 has already returned to normal, and that this is not the case.
  • It is clear from the numbers that since 2016 (with some exceptions) there has been basically no growth in most of these property prices.

Where to from here for property?

  • One’s first thought would be that the recent sharp declines in interest rates should place upward pressure on property prices seeing that the affordability of property has improved. However, I do not see this happening for the majority of properties, given our current challenges with the Corona virus pandemic and the general economic circumstances. This may well be the case for more expensive properties, which will ironically drive an even larger distinction between those who already live comfortably and those whose struggle.

What this will most probably lead to is that most tenants will become homeowners since the amount that they pay as rent is now close to the amount they will be paying towards their mortgage for the same property.

  • I believe the saying “location, location, location” has been important in the past, and even more so going forward. I most certainly expect there to be more property trades, but that these will not necessarily lead to widespread increases in property prices.
  • If you are currently renting and you are planning to buy property as a primary residence (not as an investment), I am of the opinion that you won’t find better opportunities to do so than what there currently are.

Andró Griessel is a certified financial planner and director of ProVérte Wealth and Risk Management. Contact him at info@proverte.co.za.

Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.

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