Rental property struggling to shake recession

Gareth Stokes, FAnews Online Editor

South African investors who rely on rental yields could be in for a difficult 2010. Rode & Associate’s Q4 2009 Property Market Report refers to an ongoing ‘pinch’ across the rental property universe, including commercial, industrial and residential proper

Rode & Associates assesses rental vacancies on a scale from 0 to 9, with 0 being largely let and 9 being mostly vacant. The group says industrial vacancies in major industrial nodes increased to between 2 and 3.5 in Q3 2009. “The principal risk to the outlook for capitalization rates remains the scaled-down expectations regarding the direction of real rentals,” says Rode & Associates economist, Erwin Rode. He believes property investors will create additional price pressures in this segment as they will demand higher income returns from their properties to compensate for deflated capital-returns. [A capitalisation rate is similar to the forward earnings yield on an equity investment.]

Buy-to-let rentals under pressure

Owners of second properties are experiencing some resistance to higher rentals. According to Rode & Associates flat rentals showed lacklustre growth through 2009. Durban showed the best annual growth with 5% as opposed to “rentals in Johannesburg and Cape Town, up a meagre 2%.” Low rental growth was recorded for residential (house) rentals too. “As residential rentals have a heavy weighting of 16.4% in the Consumer Price Index (CPI), these figures naturally are good news for inflation,” says Rode.

Softer demand is impacting the building industry too. “Real gross fixed capital formation in residential buildings contracted 8% in 2009,” says Rode. Over the same period, growth in non-residential building activity fell to just 7%, the lowest level in four years. The result is declining profit margins for contractors involved in the building trade and a severe dip in the building confidence index.

Five reasons house prices will remain under pressure

Last year was tough for homeowners. Absa’s House Price Indices, 7 December 2009, reveals nominal house price deflation of 0.5% in the first 11 months of the year. Is there any good news? Rode says homeowners could take solace from the recent bottoming in house price declines, evident since April 2009. But he quickly counters the good news by warning that the residential property market is in for a drawn out recovery. “It remains highly unlikely that the recovery in nominal house prices will result in a change in the direction of real house prices any time soon,” says Rode. Absa only expects nominal house price growth of 5% through 2010. The experts say inflation will (at best) dip below the upper level of the Reserve Bank’s 3% to 6% inflation target – and that means homeowners could face another year of real house price contraction!

Why will residential property remain flat? The Rode & Associates report identifies five factors in support of stagnant real house price growth in the near term. The first is the grim prospect for the country’s finances. Economists expect the budget deficit will widen as government struggles to balance its burgeoning social commitments with dwindling personal and corporate income tax revenue. A second stumbling block to house price recovery is the country’s rising unemployment number. South Africa Inc has shed the bulk of its boom-time jobs in an attempt to deal with the short-term ravages of recession. The third factor is house prices remain high in real terms. Rode notes that house prices have not fallen significantly from the record high levels reached during the last house price rally. High levels of household debt and the “constraints on economic growth [imposed by the ongoing] electricity debacle” will further dampen prospects.

Editor’s thoughts: The property articles we’ve read since New Year are incredibly upbeat. Estate agents conducting business at South Africa’s top seaside holiday destinations boast of ‘record’ activity. There are two problems with this apparent turnaround – sales volumes are improving off a low base and largely confined to top end properties. Do you think house prices will improve markedly through 2010? Add your comments below, or send them to gareth@fanews.co.za