Does buy-to-let make sense when house price growth slows?

As house prices remain under pressure the property pundits are crowing for investors to get back in to buy-to-let property. The argument is that investors will benefit from the combination of lower prices and higher residential rents. Trafalgar, which pub

Dig deep to keep your second property

What this means is you have to dig deep to finance the difference between cash outflows and inflows on your investment property. In the above scenario your monthly shortfall (assuming 100% occupation) would be approximately R6 700. Those who own second properties will agree that this is an ambitious estimate. In reality the gap between bond payments and levies on the one hand, and rental income on the other can be even wider. There is some benefit in that the annual loss on the investment can be offset against income tax… But the real clincher for property investment has been the capital gain…

Over the last decade residential property has returned in the region of 14% annual compound growth… It’s not as good as equities; but certainly beats cash and bonds over the corresponding period. An investor who bought a second property ten years ago should be sitting pretty right now. The question that needs to be asked is whether we can expect house prices to show similar capital appreciation in the next 10 years. If you think the average price for a sectional title property will hit R2.4m by 2018 then the answer is yes… But prevailing market conditions will make this target difficult to achieve.

Even the most bullish property analysts expect 2008 and 2009 to be tough years – with some expecting the first signs of an upswing in residential property prices to occur only in 2010. In this scenario house price growth over the first three years of the coming decade will be flat – and investors will be forking out loads of free cash for an asset which is gaining no value…

A ‘wait and see’ approach makes sense for now

In the above example the price-to-rental ratio is 11 times. In other words the average property price of R669 000 is 11 times more than the gross rental achieved. Schafer believes that this ratio needs to drop to between seven and eight times for rents to be at an appropriate level. That means one of three things must happen going forward. House prices must fall, rentals must increase or house prices must fall and rentals increase at the same time. If we assume zero house price growth in the next three years, then rentals will have to increase by some 15% per annum to bring the ratio down. And that’s going to be a steep ask.

At the moment it makes sense to delay purchasing an investment property – at least until there’s clear evidence the interest rate cycle has peaked. The latest numbers aren’t promising. Statistics SA revealed this week that CPIX had reached 11.6% with producer prices growing at 16.8% for June. Some economists now believe that inflation will top out at 13% or more, meaning the Reserve Bank will have to hike interest rates two more times this year.

We’re holding thumbs that these steps aren’t necessary… Either way we’ll have a better idea after the Monetary Policy Committee’s next meeting in two weeks time.

Editors’ thoughts:
Buying a sectional title property as an investment is a big step for the small investor. There are a number of risks that have to be considered: will you find good tenants, is the body corporate secure and will property provide real growth over the longer term. And initial cash flow projections can be intimidating... Are you prepared to sink R6 700 per month into a buy-to-let property given the outlook for residential property over the next three to five years? Add your comments below, or send them to gareth@fanews.co.za