Tuesday, 23 November 2010

Reserve Bank cuts again, but will it matter?

Last week, Reserve Bank governor Gill Marcus announced yet another rate cut, bringing the repo rate down to 5।5% and prime down to just 9% - the lowest rate the country has seen since 1974.

The move was not unexpected. Inflation has been close to or within the 3-6% target range for about a year (see chart) and has for several months surprised on the downside, while growth remains somewhat feeble, as illustrated by recent weak manufacturing data. In addition, the rand continues to display Schwarzenegger-like strength against the dollar (see chart), and, as Ireland teeters on the verge of a debt meltdown, the global economy looks more and more risky.

Against this backdrop, then, the decision to cut rates was not a surprise। It is an open question, however, whether or not the cut will have the kind of beneficial economic effects that many hope for.

In general, rate cuts tend to have two stimulating effects on the economy. First, they encourage households and businesses to borrow (and hopefully spend and invest) more, and second, they tend to weaken the currency and thus to stimulate exports. But will either of these things come to pass in South Africa, given the current context? Let's look at each in turn.

It's highly questionable whether the latest rate cut will have much effect on consumer or business borrowing.

On the consumer side, people just don't have much capacity to borrow. As the FNB Property Barometer noted last week, "The most recent Reserve Bank Quarterly Bulletin indicates that household levels of indebtedness remain stubbornly high, with the debt-to-disposable income ratio for the 2nd quarter (of 2010) at 78।2%, not far below the all-time high of 82%.

This would suggest that households as a group are not able to aggressively grow their borrowing off such a high base."

Given this, it's unlikely that the latest rate cut will boost borrowing; more likely, South Africans will try to pay down their debt as their monthly repayments decrease.

This isn't written in stone, of course। After all, last week's retail sales numbers showed that sales rose by 0.4% month-on-month in September, and 6.1% year-on-year. This growth soundly beat analysts' forecasts of around 4.7%, and suggests that South African consumers are still willing to spend.

But being willing to spend is not the same as being able to borrow and it looks like South African households are still too deep in hock to think of taking on more debt just yet। Backing up this view, last week's FNB/BER consumer confidence index reported a slight fall in the fourth quarter. Overall the index has been stuck between 14 and 15 this year, suggesting that consumers are no more upbeat now than they were at the beginning of the year, and making major new borrowing unlikely.

On the business side, there's nothing to suggest that South African businesses will borrow more at lower rates। Businesses borrow primarily when there are opportunities available for them to profitably invest in, and the current climate of uncertainty is not encouraging of such investment.

When it comes to weakening the currency, it's again not clear whether or not the rate cut will help. There's no doubt that the government is keen to see the rand weaken against the dollar; finance minister Pravin Gordhan announced measures to weaken the currency during his recent Budget speech, including further exchange control relaxation and the further accumulation of foreign exchange reserves, and economists have speculated that a general push to weaken the rand was behind last week's rate cut, although Marcus was adamant that this wasn't the case।

Either way, however, it seems very unlikely that South Africa can actually do much about the level of the rand. As Marcus noted, "Since the previous meeting of the Monetary Policy Committee [in September], the rand has appreciated by over 3% against the dollar. This has been despite lower domestic interest rates and the higher pace of reserve accumulation."

In large part the problem is that even after 650 basis points in cuts, South Africa's interest rates are still high by global standards (see table), and will doubtless continue to attract hot money (foreign money from investors looking for better yields), which will keep the currency strong।

In addition, a lot of rand/dollar volatility is actually just dollar/euro volatility in disguise, and so events in the US and Europe, which South Africa can do nothing about, are often the major drivers of the currency। Overall, then, it's unlikely that a 50 basis-point cut in domestic rates will have much effect on the rand.

What, then, can we conclude about the latest rate cut? While the reasons behind it are obvious, solid, and sensible, it remains an open question whether or not it will pay off। Given current circumstances, there seems to be no easy way for the cut to boost the economy through currency weakness or increased borrowing. Only time will tell if we can cut our way to faster growth.

Write to Felicity Duncan: felicity@moneyweb.co.za

*This article first appeared in Discovery Invest

Friday, 12 November 2010

Buy a house – but how?

If you buy a house that has been lived in for a number of years it will cost you about 30% less than if you buy a brand new place that has never been occupied before according to figures released by First National Bank last week.

That got me thinking about the high cost of building and the more research I did – and the more thinking I did too – the angrier I became. Angry because building materials suppliers and property developers are ripping off the South African consumers.

A brand new ‘affordable’ apartment of 30 sqm costs around R300k in different parts of South Africa. It can be considerably more if you’re buying something in Clifton or Camps Bay but the average cost per square metre for an ‘affordable’ property in reasonable suburbs (including Mitchell’s Plain or Cosmo City) is around 10k per square metre.

Talk to the developers and they say the high costs of developing a site, combined with the high costs of labour and materials determine the price of the property when it is released onto the market.

All the developers are really quick to claim that the profit levels are minimal particularly when the money is tied up for so long before the first unit is sold. So if they’re not making good profits, why are they doing it?

The answer is actually that they are making huge profits and they’re just fudging their answers to dissuade me (and you) that they’re making lots and lots of bucks.
Much the same pattern applies to material suppliers. These organisations blame everybody else except themselves for the exorbitant prices of cement, bricks, plaster, tiles, fixtures and fittings and even glass.

The manufacturers and suppliers point fingers at the retailers claiming that they are the ones who are keeping prices high; then they point another set of fingers at the high costs of transporting their products from the factory to the site (or the retail outlet). They even blame the low productivity of workers for the high prices of products made for the building industry.

Do they blame themselves or do they reduce their margins? Not a chance. In fact year after year your large material suppliers provide handsome dividends for their shareholders. So, like developers, they too are making money – and lots of it.

The final culprit in this rather depressing cycle of profiteering is the banks themselves. You see it’s the banks that are prepared to fund the developers and then grant the bonds for each pokey little flat measuring five metres by six metres into which has been crammed a kitchen and bathroom too.

Recently, Human Settlements Minister Tokyo Sexwale urged developers, material suppliers, architects and engineers to come up with innovative ways to resolve the housing problems that face South Africa.

Well, here’s a thought Mr Minister: how’s about getting the developers, the materials suppliers and the banks to stop profiteering. How’s about getting them to stop driving prices higher and higher?

How can we do that?

Well let’s look at the existing position first of all. One of the attractions for buying a new property – particularly for first-time homebuyers – is that a new property is free from transfer duty and, in many cases, first-time buyers even qualify for 100% bonds.

Sometimes buyers are supported by a developer who offers a cash-back advance to them if they sign the deal. In fact, on a 140 sqm house costing R1,4-million I was offered a R50k cash-back (to spend on new furniture or other things I was told) if I agreed to buy the home.

If I was prepared to buy a slightly bigger place, costing R1,6-million then I’d get R100k cash-back advance. Sign the deal, get the money and spend it on a new plasma TV for the lounge, curtains for all the bedrooms, new furniture for all the rooms, buy some new appliances and so on. Even spend it on having a holiday after all the stresses of moving if I choose to.

And developers tell me that they’re not making handsome profits. Pull the other leg Mr and Mrs Property Developer.

Do you ever hear about a cash-back advance on the sale of an older property? Do you get any relief on transfer duties, bond costs, legal fees or any of the other charges that are added to a property transaction? You don’t even get a discount on stamp duty.

So what we know, clearly, is that the deposit, the transfer fees and the other charges make older properties unaffordable for first-time buyers unless they have a large amount of cash in their pockets to spend on the property.

So the stumbling block that’s preventing sales of second-hand homes is the additional costs that must be covered. That being the case, Mr Minister, why don’t you and your advisers come up with a way to reduce those costs or at least make them affordable for many millions of South Africans?
Of course the argument is that developers are paying Value Added Tax on the materials they buy and because of the VAT the property doesn’t attract transfer duties.

So what about a VAT amount that gets included in the sales price of older properties (and therefore is included in the price) instead of transfer duties.

That way people could get a bond (including VAT) for the second-hand property they want to own and not pay any transfer costs at all. Sure, they’d have to cover the legal fees to feed the ever-hungry attorneys that do all the paperwork but those costs are relatively small compared with the many other charges.

Perhaps there are other ways that you, Mr Minister, can come up with to resolve the sales of property in the second-hand market and I think that there are many possible solutions too. But the reality is that the problem of transfer fees, deposits and other costs must be addressed.

More importantly than that, though, is that if you re-energise the second-hand property market the bottom will fall out of the market for new properties. Particularly so if banks come to this party and provide the bond finance required to buy older properties.

If that happened, the price of new homes would plummet.

And, if developers stop developing new properties, the materials suppliers would find that their sales levels fell sharply and they’d be forced to do something about their prices too. Like a pack of cards, the materials prices would come tumbling down too.

And so the entire cycle for reducing costs would start to work: Materials prices fall; new property prices drop correspondingly and stay there until new buyers come into the market and start buying properties that are actually affordable.

But to claim, as developers do right now, that a pokey little apartment costing R10k per square metre in a distant suburb far is ‘affordable’ is nonsense.

If you ask me, affordable is about half of that?

*Hartdegen writes a regular column for Property24.com. The content of his columns constitutes his personal opinion and doesn’t pretend to be facts or advice.

Friday, 5 November 2010

Foreign investors eye South African real estate

South Africa is seen as one of the growth nodes and the gateway to the continent.

At a recent commercial property conference held in central London, a strong focus was taken on distressed property markets, whereby it was confirmed that advanced countries would still see pain in their property markets for some time but developing economies would strongly outperform sluggish northern hemisphere nations.

According to Auction Alliance, CEO, Rael Levitt, who attended the conference at the invitation of the Royal Institute of Chartered Surveyors, many speakers, economists and analysts felt that China, India, South America and Africa were the regions where property markets would recover quickest and provide the strongest returns as the global economy returns to health over the next five years.

South Africa was mentioned as one of the growth nodes where the country was not only accommodating an influx of foreign labour from other African countries but was rapidly becoming the gateway to the continent.

According to Levitt, several delegates believed that when international behemoths such as Walmart, NTT and Zara invested in Africa, they would use South Africa as their regional head office for a pan African roll out strategy. "This creates demand for local, commercial real estate," says Levitt who followed the conference with a four day tour of the UK's largest auction houses, including Allsop, Cushman and Wakefield, Barnard Marcus and others. ‘'This is an annual trip I take to see whether our auction business is lined up with the world's most established and reputable auction companies."According to Levitt, this was the first time that he felt that South African property was way ahead of European markets, which are in great distress at the moment. "They see South Africa as an exciting emerging economy and, despite the global downturn, a strong investment destination, which would still grow sharply."

A strong Rand, first world infrastructure and renewed foreign investment will make South Africa a popular choice for global property investors, explained Levitt. One must remember that on the commercial property side, besides the investment in Cape Town's V&A Waterfront, there hasn't been enormous foreign investment in local real estate. With the strength of our emerging economy, now palatable to offshore investors, we may finally see foreign investors chasing South African industrial, office and retail property.

Unlike the UK and the USA, credit growth in South Africa was pushed up mainly by demand from the household sector, and this sector is likely to remain the main driver of credit growth during the second half of the year, following the interest rate cuts, income growth and some improvement in employment prospects.

Although many analysts believe that interest rates are likely to remain unchanged at the next meeting of the Reserve Bank's Monetary Policy Committee, given the uncertain nature of the recovery, a favourable inflation outlook and a strong rand, a further rate cut remains a possibility. "We have already found that the last rate cut gave impetus to the market and increased buyer demand.

Another rate cut will lower yields and boost the market," said Levitt. This is a positive for foreign investment and we see interest growing in both the physical and listed real estate sectors.

Unlike many banks globally, the five major South African banks are extending credit, albeit cautiously. Growth in mortgages was firm in August, rising by 1.1% m-o-m and 4.8% y-o-y. Despite the fact that the overall trend remains weak, consumer confidence is likely to remain firm during the remainder of the year as worries about job losses abate with better general economic conditions compared to last year.

Foreign investors take comfort in the strength of South African banks and, despite HSBC not pursuing the acquisition of Nedbank, South African banks are held in high regard for the way they are weathering the global downturn. Another positive factor for foreign investors is the fact that household balance sheets should improve following high wage settlements reached during the negotiation season. This, together with lower interest rates and inflation, should keep household spending positive and stimulate demand for credit.

However, part of the benefit could be offset by tight credit standards and high debt levels, which will prompt some consumers to use the favourable interest rate environment to settle their debt rather than applying for more credit.

Whilst corporate demand for credit is likely to remain weak as the private sector remains wary of accelerating capital expenditure in the face of ample spare capacity and the fragile economic recovery, foreign investment in retail, services and mining may boost business confidence in the medium term. T

hese are all optimistic signs for the commercial property market and the reasons why South Africa is being viewed as an attractive investment destination.