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Who to believe in the buy-to-let debate

19 July 2010 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

A couple of days ago I read an article warning of declining property rentals as a flood of properties ‘reserved’ for the World Cup are returned to market. The author advised property investors to brace for another period of tenants calling the shots. At b

The survey points to a certain despondency amongst real estate agents. “Despite improving rental market fundamentals, buy-to-let agent confidence remains weak,” says FNB. Is this apathy justified? Before we unpack the estate agent view we need to know how their opinion is measured. FNB says they ask each estate agent for their expectations regarding the near term buy-to-let market. If they expect the market to improve they indicate a rating of 1. A weaker marker view is indicated with a -1, and an unchanged view with a zero. “Over the past three quarters, we’ve seen a steady decline in the FNB Buy-To-Let Confidence Indicator from 0.15 in Q3 2009 down to 0.037 in Q2 2010,” says Loos.

A long slow road to recovery

The survey suggests buy-to-let activity is in the doldrums, with buy-to-let buying expressed as a percentage of total property buying reaching a new low of 7% between April and June 2010. This is worse than the 9% recorded in Q1 2010. “Along with this decline, agent confidence in the near term prospects for this segment of the property market also deteriorated in the quarter,” observes Loos. Was there any positive news? FNB says the estate agents surveyed point to a slow improvement in the gross yields on rental properties. It’s a start, but pessimists will quickly dismiss the trend as one of declining house prices and ‘sticky’ rentals as opposed to a real turnaround. In other words the up tick in gross yield is a reflection of a worsening rather than improving property market.

An even more negative observation is that gross yields on buy-to-let properties remain at the rather unattractive levels they were pushed to during the property boom of 2002 to late 2006. This could be due to one of two factors: either rentals haven’t kept pace with inflation, or property prices remain well in excess of fair value. The value debate is underpinned by the dwindling number of completed house transactions. An area report for a nice suburb not too far from where I stay, generated by Lightstone, reflects 118 housing unit (full and sectional title) sales in 2004, 95 in 2005, 152 in 2006 and 95 in 2007. But the wheels have since fallen off, with 60 transaction in 2008, 39 in 2009 and only 26 year to date! So whether you blame the recession, the National Credit Act or your local bank, the number of completed house sales remains at rock bottom – an observation that doesn’t sit well with estate agents.

Deciding to invest in buy-to-let

Is an estate agent the right person to approach for advice on buy-to-let opportunities? In our experience their focus is on selling houses. Investment merit is far removed from their primary objective of achieving the sale. Let’s look at a quick example to illustrate my point. I recently spoke to an agent who said she had an excellent investment property in one of Gauteng’s oldest golf estates. The entry-level townhouse had rental contracts in place till August 2011, and the asking price was a seemingly reasonable R1.8 million. Sounds great, I said, doing some numbers in my head. How much is the tenant paying?

Her answer almost triggered a fit of hysterical laughter. The tenant was paying R8 000 per month… There’s no investment case at that price. Strip out the rates and levies (usually paid by the property owner) and you’re left with a net rental income of R78 000 per annum, a mere 4.3% yield on capital. If you do a lot of manipulating – offsetting interest against income – and factoring in things like gearing and the long-term recovery in house prices, you might be persuaded to sign on the bottom line. The point I’m making is the estate agent’s ‘excellent investment’ is anything but. Should an investor consider take on the risks associated with this property investment – including illiquidity and high transaction costs – when the risk free return on cash is higher?

FNB say buy-to-let investments are about buying into a rental income stream. They also claim “that yields are rising, in some instances to a level where rental income can cover 100% of your bond repayment.” Clearly they’re playing in different housing markets. I’d love for an estate agent to send a couple of these opportunities my way! The above example would require a monthly mortgage repayment of close to R17 500 against a gross rental income of R8 000! It’s no wonder FNB advises would be buy-to-let investors to “proceed with caution” under current economic conditions.

The facts speak for themselves

FNB highlights four potential stumbling points you should consider before purchasing a second or third home. First: salaried individuals shouldn’t factor in discretionary rewards such as bonuses and share options when calculating their ability to repay debt. Second: you must consider the impact of non-mortgage expenses like municipal assessment rates and maintenance costs when assessing the affordability of your investment. Third: provide adequately for defaulting tenants, bearing in mind the TPN Credit Bureau says only 78% of tenants were “in good standing” at the end of Q1 2010.

And the fourth observation: Remember that SA currently finds itself at relatively low interest rate levels! As the economy recovers, we could easily see 4% to 5% hikes in interest rates in the next up cycle. The resulting increase in mortgage repayments must be factored in to your assessment of income and expenses before purchasing a buy-to-let property.

Editor’s thoughts: There you have it… Buy-to-let at your peril! We’re not saying investment in property is a bad idea – just make sure you know your stuff before jumping in. Have you been on a property hunt recently – and have you found buy-to-let investments offering gross yields that would cover your bond repayment? Add your comments below, or send them to gareth@fanews.co.za

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