Good times not over yet

Posted On Monday, 19 November 2007 02:00 Published by
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After more than a decade of being rather poorly rated as an asset class, the South African real estate sector has finally come into its own

In fact, property has been one of the best places for investors to be over the past three to four years. The residential sector was the first to turn the corner in the early part of this decade.

And what started as a slow recovery soon accelerated into a full-blown boom, with house prices more than doubling over the past four years. It didn't take long for the commercial property cycle to follow suit. Investors in directly held commercial property and JSE-listed property funds have probably seen equally spectacular - if not better - returns than their residential counterparts.

The key question is: Where to from here? How long can the good times continue to roll, particularly given the seven consecutive interest rate increases since mid-2006 and stricter mortgage lending criteria introduced by the National Credit Act in June. If the market should slow significantly over the next few months, should you sell now before that happens or will weakness present further buying opportunities? Property analysts and industry players, of course, have mixed views on where the various sectors of the market are heading and what approach investors should adopt. But one thing is clear: residential property will probably be hardest hit over the short term. 

Residential property

It appears the past two rate increases (in August and October) dealt a hefty blow to an already soft housing market. Estate agents and mortgage originators reported a significant drop in housing activity over the past three months, with sales down around 30% from early 2007 levels.

Many prospective buyers - whether they're first-timers, upgraders, buy-to-let or leisure property investors - have understandably been forced to place buying decisions on hold. Homeowners' monthly mortgage repayments have surged by a hefty 25% since mid-2006. At the same time, consumers' buying power has been significantly eroded. Industry players are expecting a tough few months ahead as the reality of the 350 basis points rate hikes - and the possibility of more to come - price more potential buyers out of the market. Auctioneers are apparently already seeing a marked rise in forced sales. For example, the Alliance Group has reported a 60% increase in its distressed sales book in third-quarter 2007 (year-on-year).

Apparently, the bulk of those represent buy-to-let properties, holiday homes and speculative buys in golf estates in the upper mid-end of the market priced between R1m and R5m. Although no one expects SA to head for the same mortgage crisis as that of the US, banks are nevertheless readying themselves to deal with a rise in bad mortgage debt over the coming months. The big worry is that large numbers of investors battling to meet the additional repayments on multiple mortgages begin dumping properties on the market. If there's a rush of sellers over the next few months while buyers continue to retreat, prices will no doubt come under pressure.

True, house prices were still rising at double-digit rates in October: around 14%, according to Absa's latest house price index. But it now seems increasingly likely that house price growth could dip below 10% early next year. Some commentators say it's possible that prices could even drop in nominal terms in 2008. But it's not all bad news for the residential property market. There are still pockets of strength that are likely to continue to show double-digit price growth over the next 12 months. Most commentators expect the lower end of the market priced below R500 000 and the top end priced at R10m plus to show the best returns over the short term. SA still has a massive housing backlog and a rapidly growing middle class aspiring to home ownership, which should continue to drive demand at the lower and middle end. Activity at the very top end also remains brisk as buyers in that bracket are often cash buyers or overseas investors less sensitive to interest rate hikes than their lower and middle income counterparts. 

Commercial property

It seems that demand for commercial property hasn't yet been affected by higher interest rates to the same extent as the residential market. Demand is underpinned largely by institutional property owners and listed funds trying to grow their property portfolios. That's created somewhat of a shortage of prime investment stock and suitable development land.
 
Institutions backed out of commercial property in the mid to late Nineties, selling off large chunks of their portfolios to reduce their exposure to property as a percentage of total assets. The general notion then was that offshore diversification and more liquid asset classes, such as equities and bonds, were a far better bet than fixed property. That sentiment has changed quite dramatically in recent years.

Bricks and mortar investments have staged such a comeback that asset managers can no longer afford not to be exposed to property. British-based research company Investment Property Databank (IPD) last year ranked SA as the world's second best performing property market. SA's IPD index, representing commercial property portfolios worth R111bn, delivered total returns of 26,7% in 2006. In 2005 SA was in the number one spot worldwide, with an all-time high return of 30,1%. 

Listed property

Listed property has probably been the biggest beneficiary of the switch back to property by income-chasing fund managers and institutions. The sector has seen a surge of new listings and consolidation activity, which has helped increase its market cap nearly seven fold over the past five years: up from only R15bn in 2002 to currently close to R100bn. Listed property prices have also been remarkably resilient in recent months, despite higher interest rates and ongoing fears of a global credit crunch.

It seems that the key reason for the sector's relative strength is that there's simply not enough stock to meet demand. Analysts say that when prices dip, large pension fund managers, such as the Public Investment Corporation (PIC), use this as a buying opportunity, pushing prices back up again. The PIC has in recent months become an aggressive buyer of commercial property - listed property in particular - in a bid to grow its exposure to bricks and mortar. It seems that buying support is also increasingly coming from retail investors switching from residential to commercial property.

Property analysts expect the market to be further underpinned by a growing number of offshore asset managers starting to place JSE-listed property funds on their buying lists. Less than 5% of listed property is now in foreign hands, while offshore ownership of general equities on the JSE is around 20% to 25%. Industry players say there's a good chance that the SA listed property index will be included in the prestigious FTSE EPRA/NAREIT global real estate index in first quarter 2008, a move that will place SA property stocks firmly on the radar of large European fund managers.

However, most analysts agree that investors shouldn't expect share prices to continue to surge ahead at 30% to 40%/year, as seen over the past few years. Share price growth is expected to be relatively muted over the next 12 months. The focus will shift increasingly to income growth.

Analysts still expect double-digit growth in income payouts for at least another 12 months, with recent rate increases not expected to have any noticeable effect on the sector's short-term earnings growth outlook. So although capital growth prospects have slowed, listed property remains a good bet for income-seeking investors.

However, stock-picking has become the name of the game. Until recently investors could buy just about any of the sector's 25-odd counters and still be assured of returns of 20% plus. That's no longer the case, with the performance gap between the higher and lower rated stocks expected to widen over the next year. Besides the quality of a fund's underlying property portfolio, analysts say a key driver of performance in future will be the strength of the management team.


Publisher: Fin Week
Source: Fin Week

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