A few rays start to shine on SA real estate Personal Finance on September 12, 2009 The local residential property market was badly affected by the economic downturn, but listed property investments, which are in commercial and industrial property, have not suffered to the same extent. Overall, the experts are cautiously optimistic. By Neesa Moodley-isaacs The outlook for listed property for the year ahead compares favourably with the outlook for assets such as bonds and cash, while the recent decrease in interest rates and the banks easing up on lending criteria bode well for the residential property sector, property analysts say. The South African Listed Property index recorded a total return of 1.91 percent for August, while the Property Loan Stock index and the Property Unit Trust index recorded total returns of 1.78 percent and 2.28 percent for the same month. The historic yield of the South African listed property sector was 8.73 percent for the year to August. Zayd Sulaiman, an investment manager at Catalyst Fund Managers, says that even though growth is slowing in listed property, it is still exceeding inflation expectations, and the sector offers a better income stream than cash or bonds. Sulaiman says that, assuming growth of about 8.5 percent in distributions over the next year, listed property offers a forward yield of about 9.47 percent (the historic yield of 8.73 percent plus growth of 8.5 percent). "This compares favourably with a 12-month deposit rate of approximately seven percent on cash and the yield to maturity of 8.8 percent on the RSA Long Term Gilt. In addition, the income on listed property has the potential to grow, while the income on bonds is fixed," he says. Vuyani Bekwa, a portfolio manager at Investec, says that because property lags the economy by about 12 to 18 months, it might be a while before things start to get better. "If you are investing for the long term, however, property will continue to provide distribution income growth, even though this is likely to be muted," he says. In August, eight companies (accounting for 55 percent of the South African listed property sector by market capitalisation) released their interim or year-end results. The companies include Resilient, Pangbourne, Hyprop, Emira and Growthpoint. Some companies performed better than others based on the quality of their property portfolios, debt and management. "The growth in distributions received by investors across the eight companies ranged from a decrease of eight percent to an increase of 15 percent, and the market cap weighted average increase in distributions was still a robust 8.4 percent," Sulaiman says. He says the ability of landlords to set rent escalation levels is largely driven by the length of the lease in question, the bargaining power of the tenant at the time, building cost inflation and individual circumstances. "On average, property companies are still achieving rent escalation levels of about eight percent and more a year," he says. Sulaiman says that although escalation levels are down from previous levels of about nine percent, so is inflation, and a one-percent drop in rental escalation levels is not dramatic. "This is still good growth. Property still offers income at a very attractive forward yield of 9.47 percent, plus the prospect of growth in this income in excess of inflation," he says. Rental growth Over the past three to five years, market rental rates have risen faster than the escalation of rentals set in contracts. This means that when a lease expires, companies can charge higher, market-related rentals. As a result, property companies are able to achieve growth in rental levels as leases expire. On average, vacancies have increased across most property portfolios. Sulaiman says that most of these vacancies appear to follow the completion of speculative developments for which property companies are now, in the current environment, having difficulty finding tenants. And this scenario does not appear likely to improve. Speaking at the annual Rode Property Conference recently, property economist Erwin Rode said that about 568 000 square metres of retail space - planned during the property boom years - has still to come on stream in the year ahead. "With retail sales having contracted by about six percent compared with a year ago, this additional retail space could have serious consequences for many shopping centres across the country with landlords battling to either retain or attract new tenants, and many tenants battling to pay their rentals," he says. Vacancy levels Sulaiman says that if you compare the vacancy levels of property portfolios this year with the vacancy levels of the same portfolios last year, without taking into account developments, acquisitions or disposals, then vacancy levels have been largely resilient. However, some property companies with investments in smaller neighbourhood shopping centres have had a material increase in vacancy levels. "This is the offspin of consumers coming under pressure and smaller shops being forced to close or not being able to meet their rents because business is so poor," he says. Vacancies that are not a result of new developments, acquisitions or disposals are expected to increase slightly over the medium term. Bekwa says the relative performance of the listed property sector will depend very much on how quickly the economy recovers. "An economic recovery will allow tenants to expand businesses again," he says. The latest listed property report from Catalyst Fund Managers states that none of the listed property companies is planning any speculative development in the current environment, although some companies will be going ahead with developments driven by tenant demand. Residential property is looking up - experts The consensus in the property industry seems to be that the slump in the residential property market is coming to an end, with early signs of a recovery. John Loos, a property strategist at First National Bank (FNB), says that although the FNB House Price index continued to show a year-on-year decline in August, the rate of deflation has diminished, with the index showing clearer signs that the market is starting to stabilise. However, Loos cautions that it is important to realise that the economic growth indicators remain very weak despite some improvement. "Given the high levels of indebtedness in South Africa, the expectation is that the economic and property recovery over the next year or so will be moderate at best," he says. On a year-on-year basis, the house price index declined by 7.4 percent in August, a significant improvement on the revised deflation rate of 8.5 percent in July. Improved affordability due to interest rate cuts is one of the factors pointing to an improvement in the market. Interest rates have been cut six times since June last year, with the prime interest rate being reduced from 15.5 percent to its current level of 10.5 percent. According to the FNB House Price index, the rate cuts have led to the beginning of a decline in the level of arrears for FNB clients. There has also been a sharp decline in insolvency rates - second-quarter insolvencies were down by about 40 percent year-on-year. However, Loos cautions that the recovery in households' ability to service debt is a "high risk" recovery, because it depends almost solely on interest rate cuts, and the overall level of indebtedness remains high. Loos says that while the property market looks set to move back into price inflation early next year, the expectation is that 2010 will see single-digit inflation and probably little if any "real" house price inflation (house price inflation that outstrips consumer price inflation). Jacques du Toit, Absa's sectoral analyst for secured lending, says house prices are expected to decline further in nominal terms towards the end of this year and probably also into early next year, but the pace of deflation is expected to slow down in the second half of this year. "For 2009, nominal house prices are expected to decline by between three and 3.5 percent after prices increased by 3.7 percent last year. "In real terms (after inflation), prices are projected to decline by about 10 percent this year. Real house prices are set to decline for most of next year before turning positive, with nominal house price growth expected to be relatively low in 2010 and consumer price inflation expected to average around six percent next year," he says. Standard Bank and Absa relax their lending criteria A relaxed lending environment is one of the biggest drivers of a recovery in the residential property market, says Saul Geffen, the chief executive of mortgage originator ooba. In the past year, banks tightened their lending criteria and you were not able to get a home loan without first putting down a deposit of between five and 20 percent, depending on the price of the home you were buying. However, there has been a slight shift by banks. In the past two weeks, Standard Bank and Absa have announced that they will be offering bigger loans to prospective homeowners. "We have seen increased competitiveness between the banks in the past four months and a marked increase in (home loan) approval rates across the board," Geffen says. He says banks are targeting people who bank with other institutions. "The move by banks to relax deposit requirements is a positive development for the property market," he says. Standard Bank Peter Schlebusch, Standard Bank's chief executive of personal and business banking, says the bank has increased its risk appetite, specifically to help first-time home-buyers in the lower-income bracket. "People in this sector have been hit hard by higher inflation, job losses and the general slowdown in the economy," he says. First-time homeowners who buy properties for up to R1 million and who use the property as their primary residence can now get a 104-percent loan. The extra four percent is to help buyers cover their transfer and bond registration costs. Standard Bank is granting 100-percent loans to prospective homeowners who have a maximum combined household income of R15 000 a month. The bank is also granting 100-percent loans to people who buy properties for up to R1.5 million and who apply through the bank, as opposed to using a mortgage originator. If you want to buy a home for between R1.5 million and R2.5 million, you will still need a 10-percent deposit. Home loans for more than R2.5 million will require a 20-percent deposit. Absa Luthando Vutula, the managing executive of Absa home loans, says that, in the past six weeks, the bank has started to grant 110-percent home loans to applicants with a combined maximum household income of R11 000 a month. The extra 10 percent is to help consumers pay their bond registration and transfer costs, as well as other expenses, such as the cost of moving house. Vutula says the interest rate cuts mean that consumers are experiencing some relief. "Lower inflation and lower household payments mean that there should be a notable reduction in loans that are in arrears. These reasons, combined with the slight improvement in the property market, have led us to review our lending criteria," he says. However, Vutula cautions that 100-percent home loans across the board are not likely to happen soon. "Property economists are expecting house price growth to be between three and four percent by the end of the year. Given those figures, it doesn't make sense and it would be irresponsible to grant 100-percent home loans across the board. "It is more important for consumers not to reach a point of negative equity - where the amount of money they owe on their home loan is greater than the value of the property," he says. Published on the web by Personal Finance on September 12, 2009.