Expensive market means investors chasing good returns will have to become experts in their chosen fields, writes Chris Needham

WHETHER or not you believe residential property has entered "bubble" territory, the latest Trafalgar Inner City Report for 2005 shows that in South Africa’s inner-city areas at least, demand for accommodation is growing and keeping the market buoyant.

This week property educationists YDL held their quarterly property market update, to gauge if the market is in a bubble.

Maarten Ackerman of private client wealth management company Citadel Investment Strategists offered a fund manager’s perspective at the debate. He defined a bubble as a sharp rise in the price of an asset which attracted new buyers interested in profits from trading in the asset.

Ackerman said one could recognise a bubble by certain classic traits, namely extended valuations, excessive leverage on the part of the buyer, a surge in supply and speculation.

He offered several statistics that supported the South African residential market being in a bubble — not least the fact that mortgage debt as a percentage of total debt had been creeping up.

However, he said that "even if you can see an asset class with extended valuations, it doesn’t mean it’s going to burst. For instance, the UK housing market is experiencing a slow puncture and prices are slowly coming down".

The Absa House Price Index, released this week, showed that in September nominal year-on-year house price growth of 17.6% was recorded. This was the slowest since December 2002, when it was 17.3%.

According to the latest Absa report, "nominal house price growth of around 21% is projected for the year, compared with growth of more than 32% recorded in 2004.

"The affordability of housing, taking into account house price, income and interest- rate trends, will remain an important factor over the next 12 months, especially for first-time and low- to middle-income home buyers. In 2006, nominal house price growth of 5% to 10% is expected."

Ackerman said that if one looked at houses in the same way as stocks and worked out a price:earnings ratio for them (roughly arrived at by dividing the price of an asset by its earnings) then residential property was currently at extended valuations of nearly 14 times — the highest it has ever been. This compares with a PE of around 12 times during the early 1980s peak.

He suggested that at their current levels, house prices would have to stay flat for nine years for housing PEs to get back to their long-term averages, assuming rentals rise in line with inflation.

"It is a very expensive asset that you are buying today," he said, pointing out that a buy-to-let flat in an upmarket area (assuming it is bought for cash) would give you about the same yield as cash in the bank.

However, he said that the Absa House Price Index showed price growth was slowing, so this could cool the overheated market without there being a crash in prices.

Property economist Francois Viruly said that growth in prices had been slowing since the middle of last year but warned that "the supply [of new developments] carries on when the game has changed".

He also said that "there are many buyers out there who have not seen a rise in interest rates". South Africa’s booming property market has inexperienced players who may not be adequately prepared to absorb the shock of any interest rate hike. Viruly suggested that with the increasing densification of urban areas, particularly Johannesburg, "transport and lifestyle is going to be the biggest story in the next 12 months", with central estates such as Houghton likely to experience greater subdivision of stands as people become increasingly reluctant to spend hours in traffic between work, play and home.

His suggestion that opportunities are not across all sectors at the moment supports Trafalgar’s inner-city report.

Viruly quoted Absa figures to October 2005 that showed that the luxury market segment of houses worth more than R2-million was showing poor year-on-year growth of 4.4% compared with the massive growth of nearly 25% in the more affordable middle-market segment (roughly defined as houses costing R400000 or more).

He said that investors would have to be more selective about the areas they chose, and that it was the middle market that was still likely to show good growth. Importantly, he said that though residential property was still a case of "location, location, location", in South Africa "location changes", so investors would have to remain aware of previously overlooked areas such as Buccleuch and Kelvin in Johannesburg.

Property journalist Ian Fife said he too thought that growth would come from the lower-end areas and gave Johannesburg examples such as Yeoville and Cosmo City as potential success stories.

However, he said the statistics used to value the South African market were based on a select market of 1.5 million houses and were thus not entirely representative of the situation on the ground, as there are 10 million houses in the country.

As a result, he suggested that investors become "micro-experts" in specific areas and stressed that "property is a long-term investment and an income investment", so shorter-term capital fluctuations should not rattle income investors.

Trafalgar reports that rentals in the country’s inner cities are starting to rise because of growing tenant demand. Unlike other across-the-board rental reports, Trafalgar focuses specifically on inner-city flats. While the rest of the buy-to-let market may be stagnating, the report states that "there is little evidence of a rental ceiling" in the inner city because of strong demand.

South Africa’s CBDs are, according to the report, the favoured areas for many South Africans because of affordability issues and due to their central location.

"Tenants are not always realistic about sales prices. About 80% want to buy their own property, but 46% don’t want to spend more than R100000," the report states.

It adds that a shortage of stock, combined with this strong demand, "means that prices are going to rise, perhaps even more quickly than expected" and that the entry price for sectional-title units in Hillbrow could be R100000 in three years’ time.

Trafalgar CEO Neville Schaefer says that the best bachelor flats are renting for just less than R2000 a month.

The report states that a typical inner-city bachelor flat rental in Johannesburg would be up to R1850 a month; R1400 in Pretoria and R1450 in Durban.

Trafalgar reports that its lettings have risen from 100 a month last year to 140 a month this year.