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September 2008
 
INVESTING IN RESIDENTIAL PROPERTY
– A SOUND INVESTMENT?
INVESTING IN RESIDENTIAL PROPERTY
By Jacques du Toit – Senior Property Analyst, ABSA Home Loans

The 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 hike 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 investment is the return, which is 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 to 400 m², up to R2,9mill) have increased by about 12% per annum over the past 20 years, real prices have risen by only about four percent per annum over this period, mainly as a result of high levels of inflation at certain stages during this period.

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, have been 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, 10, 15 and 20 years, an investment in residential property in South Africa has beaten most other asset classes, as well as inflation. This only applies to a situation where a house is rented in order to earn an income.

Based on the latest trends in house prices measured by the monthly Absa House Price Index, property owners who bought a house in 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/she sells now.

However, property owners who bought five to 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 a year or two ago.

With the residential property market expected to slow down further towards the end of 2008, bottoming in 2009, the second half of 2008 and in 2009 will be the time to buy property - especially from an investment and buy-to-let or 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 (five 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 into interest rates 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,
• 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 five 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 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.

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