Absa’s review of property investments in 2006

For various reasons, such as political uncertainty and a poorly performing economy, property as an asset class generally under-performed in South Africa during the mid-
1980s up to the late 1990s, according to Absa’s Property Trends report released in Johannesburg today.

However, by 2000/2001 most other asset classes were underperforming, according to the report, while South African property was recognised as relatively cheap at the time. This caused investors to take a closer look at property as an asset class, with the result that the investment status of property has improved substantially over the past few years.

Factors such as a stable political environment, a strongly growing economy, low inflation, and low interest rates between 2000 and 2005 were some of the main contributors to property becoming a solidly performing asset class during this period.

Phenomenal real rates of return on especially residential properties during the past four years or so, proved unsustainable and during the course of 2005 nominal price growth declined from about 31% in January last year to 14,7% in December, according to the report.

Albeit lower than the 32,2% of 2004, the average nominal price growth for the full 2005 came to a very acceptable 21,9% (about 18,0% in real terms). With housing in general having become much more expensive than a few years ago, the issue of affordability is now an important factor in all segments of the residential market.

The various asset classes within the property sector, which investors may consider when investing in property, according to the report, include the following:

• Buy-to-let residential property:
The strong demand for residential property, to some extent driven by a rapidly growing middle class, caused the development of higher-density residential units to increase strongly over the past five to six years.

This, together with the low interest rates, caused many new investors to flock to the investment market to capitalise on the property boom, while they were also looking for alternative investments against the background of the relatively poor performance of some other types of investment.

As a result, the buy-to-let market grew rapidly, which eventually put downward pressure on rentals, also taking into account the low interest rates, which made it easier for people to buy. Interest rates are expected to remain at their current levels throughout 2006, with the result that rentals will in general not increase significantly during the course of this year.

• Coastal and rural residential property:
The coastal and rural property markets have also put up a good performance, with the demand for these properties increasing significantly in virtually all the provinces during recent years. This development can to a large extent be ascribed to lifestyle changes.

These types of property are becoming increasingly popular as a result of the improved investment status of property, while people are increasingly feeling the need to get away from busy urban lifestyles over weekends and during holiday seasons.

Against the background of the more limited supply of residential properties in these areas compared with urban areas, prices have increased sharply along the coast and in many small, remote rural towns throughout the country as a result of higher demand for these
properties.

In the coastal provinces of the Western Cape, Eastern Cape and KwaZulu-Natal, demand and supply conditions for coastal property have, in some cases, pushed prices in all segments of the market to not far below, or even higher than the level of prices in metropolitan areas.

The leisure property market (both coastal and rural) may be driven to some extent by the more affluent households living in the major metropolitan areas in the country. Foreign buyers of local property are also largely interested in the coastal areas of South Africa. In view of supply and demand conditions for these type of properties to diverge even further in future, prices are likewise expected to escalate further.

• Inner-city residential property:
The rejuvenation of inner-city areas in the country has already picked up momentum and this will provide scope for some rapid growth in demand, new developments and prices over the next few years. Increasing traffic congestion in the future will drive people to live closer to their places of work and business centres.

The business sector in inner-city areas, especially retail outlets, will also revive once residential living of specifically higher-income households in these areas increase. However, the ultimate success of these developments will also depend on actions to prevent crime and grime to the minimum in these areas and the future delivery of municipal services and infrastructure such as electricity, water, sewage and refuse removal.

• Commercial property:
The performance of the commercial property market (retail, office and industrial) has lagged that of the residential market and the economy as a whole over the past few years. This is to some extent the result of the fact that the planning and construction phases of large commercial projects normally take relatively long to complete. Retail property developments also normally follow big residential developments after some time.

The residential market has started to cool down a bit over the past twelve months, but growth in excess of inflation is still expected over the next couple of years.

Overall real economic growth is expected to remain above 4% per annum over the next few years up to 2010. Against this background, commercial property is expected to experience a boom phase over this period.

• Listed property:
In view of the strong performance of direct property in recent years, listed property (e.g property funds and property unit trusts) performed equally well in recent times. Taking into account especially the prospects for the commercial property sector, listed property will remain an important investment class to consider in future, specifically for those investors who do not want to be exposed to the risks of being directly invested
in property.

Any investment in property, the report recommends, should take account of the following factors:

• The state of and prospects for the most important macroeconomic variables impacting on the property market.
• The state of and prospects for the property cycle taking into account the broader business cycle, as this can have an influence on further capital appreciation and rental yields.
• The purpose of an investment in property (own use; buy-to-let; speculation; asset diversification, etc).
• Specific regional and sectoral trends, developments and factors.
• Risk diversification of an investment portfolio (e.g. equities, bonds, cash, property).
• Diversification of a property portfolio (type of property, such as residential, commercial or industrial; and area, such as inland, coastal, rural or urban).
• Location is probably still one of the most important considerations when buying property.
• Possible tax implications (capital gains tax; personal income tax; estate duty; transfer duty).
• Costs (transaction costs; rates and taxes; maintenance; letting costs). Against this background, the following aspects should be taken into account when investing in property in 2006:
• Nominal house price growth was 21,9% in 2005, but the rate of growth should slow down to between 10% and 12% in 2006, mainly driven by the combined effect of the affordability of housing and interest rates remaining low over the next twelve months.
• Investors that are only now entering the property market may well be faced with little prospects of capital appreciation, while rental yields are already fairly low. However, properties that were obtained some time ago, may still render an acceptable return during the next twelve months.
• With CPIX inflation currently well under control and a much stronger rand exchange rate since late last year, interest rates are forecast to remain at current levels throughout 2006.
• The buy-to-let market appears to be saturated in certain areas. Especially residential property in the upper end of the market (say above R2 million) appear to be more difficult and are taking longer to either rent or sell.
• As direct property investment is not really a homogeneous asset class, location, type of property, and other local developments can have a major impact on the investment.
• As a general rule, property should not constitute more than between 15% and 20% of an individual’s portfolio (excluding your personal residence).
• Diversification between various types of properties in different areas is advisable.
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