Sep 28 2005 12:00:00:000AM

By: Joan Muller

PROPERTY analysts were expecting investors' appetite for buy-to-let properties to wane considerably this year as lower yields and a rising oversupply of rental stock in some areas have made residential property investments less attractive.

But that's yet to happen. In fact, more buy-to-let investors are now entering the market than before. Latest figures from Standard Bank show that in August close to 30% of all properties sold went to investors rather than owner-occupants up from around 18% two years ago.

So nearly one in every 3,3 residential property buyers is currently acquiring property for letting or investment purposes. Standard Bank economist Elna Moolman says that investor participation in the housing market has been rising steadily over the past four years on the back of lower interest rates and healthy capital gains prospects. But as rental stock increasingly came on to the market, investors were forced to settle for lower rental increases rather than have their properties stand vacant.

Slower rental growth, combined with a sharp increase in house prices, has eroded investors' rental yield to between 4% and 6% (net) on average. Moolman says that consequently, house price to rental income ratios which can be compared to the price:earnings ratio for listed shares have risen markedly over the past year, indicating that residential property is losing its attraction as an investment.

But rising investor activity in recent months suggests that investors believe there's still enough capital growth potential left in the market to make up for lower rental returns. However, that's not a view shared by analysts, such as property economist Erwin Rode.

He's repeatedly warned that the residential property cycle is close to its peak and maintains that now is not a good time to invest in buy-to-let units. Rode says that investors who have recently entered the market will be squeezed from both sides: lower rental and capital returns. He says that chances are slim that house price growth will exceed inflation over the next five to 10 years.

Says Rode: "If you buy a flat at a net income yield of 4% while the interest on your mortgage is 10%, you're going to finance your mortgage repayments out of your own pocket for a long time. It's also completely unrealistic to expect capital growth of 12%/year over the next few years, given that consumer inflation is expected to be between only 4% and 5%."

Senior Absa economist Jacques du Toit expects house price growth to slow to less than 10% next year. But others argue that buy-to-let investors should not be discouraged by the slowdown in rental and price growth. Neville Schaefer, CEO of residential property managers Trafalgar, argues that investors who adopt a long-term view will see yields rise steadily going forward as property ownership becomes increasingly unaffordable, forcing more South Africans to rent instead of buy.

He says that will put upward pressure on rentals. Trafalgar's latest rental index already shows that rents are outpacing inflation with an average rise of 8% in the year to June. So investors haven't seen their income drop as such; house prices have merely risen faster than rentals, says Schaefer.

Durban was the front-runner in the latest rental index, recording average growth of 16% in the year to June, followed by Johannesburg (14%), Pretoria (9%) and Cape Town (5,5%).

Anton de Leeuw, CEO of property educationalists YDL, says that the rental market is no doubt showing signs of bottoming out. For example, in Sandton rents for two-bedroom units have increased from R4 000/month early this year to around R4 500/month for new leases signed.

Assuming the value of these flats is around R800 000, investors are getting yields of 5,25%/year (R4 500 minus the levy of R1 000 times 12 divided by R800 000), with a reverse cash flow of R2 500/month on an 80% (R640 000) mortgage at 1% below prime.

De Leeuw says that Cape Town investors are still sitting with net rental yields of around 4%. That's due to two-bed units in Cape Town's CBD and surrounds also letting at R4 500/month but cost on average R200 000 more than those in Sandton.