Rental yields are on the decline as affordability continues to be an issue

| Article By Michelle Dickens, CEO of TPN Credit Bureau

Property market trends have a significant influence on the residential rental market. When rental values increase, so too does the gross yield. When rental escalations are negative, gross yields weaken. Somewhat counter-intuitively, when property prices increase and rental prices remain flat, gross yields deteriorate.

Income yield is an important metric in the property market as vacancies and non-paying tenants mean lost rental income and ultimately less profit for landlords. Of concern currently is the fact that in many provinces of South Africa, yields are being driven down as tenant affordability continues to be an issue.

The property market has long been subject to cycles which see it both soar and, inevitably, crash. Periods of ‘easy money’ typically see a property boom, such as the period between 2004 and 2006 when property profits peaked at 35.4% per annum, according to FNB’s House Price Index.

For every boom, however, there is also a crash on the horizon. Fast forward a couple of years and FNB’s House Price Index turned negative during the Global Financial Crisis, TPN analysis confirming as many as 28% of investment properties sold at a loss.

The residential rental market was hard hit during the pandemic. Many former tenants sought refuge with family and friends after facing income losses. As a result, the residential rental market faced the twin challenges of rising house prices as pent up demand for property ownership was unleashed coupled with negative rental escalation. Tenants in good standing – defined as those who have paid in full and on time – dropped to 73.5% in the second quarter of 2020. This has slowly improved quarter-on-quarter with 80.34% of residential tenants in good standing by the second quarter of 2021, according to the latest TPN Residential Rental Monitor.

Despite this recovery, and although paying rent is a top priority for residential tenants, affordability remains under pressure. This is made worse by above inflationary increases in utilities and municipal charges, the fact that overall rental escalations are back in positive territory and growing unemployment. South Africa’s official unemployment rate reached a record high of 34.4% in the second quarter of 2021 although predications are that this figure will increase as the impact of July’s unrest begins to reflect in unemployment data. 

Although most major provinces have seen an improvement in tenant payment behaviour above 80%, Gauteng lags with just 78.67% of tenants in good standing. Negative escalations in the province continued for the third consecutive quarter. However, if delinquent tenants and negative rental growth are risk indicators, then gross yield is the reward and in this respect, Gauteng takes top honours with gross yield at 11%.

Landlords in the Western Cape and Eastern Cape are clearly more risk averse as illustrated by the fact that their tenants are ahead of the curve with 84.78% and 84.15% respectively in good standing. However, after a year of negative rental escalations, the Western Cape is experiencing rising vacancies at 14.38%. The province, which historically outperforms the rest of the country as far as property prices are concerned and rental prices which struggle to keep up, is recording gross yields of 8.7%.

The Eastern Cape, on the other hand, has a low 4.28% vacancy rate coupled with strong demand which has allowed it to maintain its positive rental escalation of 2.09%. As a result, the province’s gross yield of 10.7% is seeing it punch significantly above the national average of 10.3%.

While KwaZulu-Natal’s tenant payment performance has improved to 80.08%, its vacancy rate has jumped to 13.95% which means it’s only just achieved double-digit gross yield of 10.1%.

The most sought after residential rental properties are in the R4 500 and R7 000 per month price band with around a third (35%) of all lease agreements made up of this segment. The majority of tenants in this segment (82.76%) are in good standing with 67.67% paying on time. Although only 4.94% failed to make payments, 10.58% paid late, indicating that cash flow remains constrained. 

Landlords with properties in the lower end of the market below R3 000 a month continue to struggle with 16.08% of tenants unable to pay rent and a further 15.72% of tenants making only a partial payment. The vacancy rate of 15.19% in this segment of the rental market indicates that landlords would prefer no tenant to a defaulting tenant.

The traditional sweet-spot segment are monthly rentals between R7 000 and R12 000. This segment continued to perform well in the second quarter of 2021 with the majority of tenants (86.32%) of tenants in good standing and close to 75% paying on time. Of concern, however, is the fact that affordability is acting as a key constraint in this segment while rental escalation remains in negative territory of -1.03%.

While lower income earners were undoubtedly hardest hit by the pandemic, middle and high end income earners also appear to be under financial pressure, according to research released by the National Income Dynamic Study: Coronavirus Rapid Mobile Survey (Nids-Cram) and the Liberty Institute of Strategic Marketing (ISM) at the University of Cape Town. The study found that while the biggest impact of the pandemic has been felt by those in poorly paid jobs, there has been a 17% drop in the number of people who earn between R22 000 and R40 000 a month, while the take-home pay from the top million households earning over R40 000 dropped by almost 14% between March 2020 and March 2021.

Given the slow pace at which the economy is growing and South Africa’s rising unemployment numbers, all indications are that affordability will continue to be the biggest constraint impacting the local residential rental market in the third and fourth quarters of 2021.