Residential demand strengthens further in the 1st Quarter of 2011

But despite stronger demand, the supply-demand imbalance appears to have deteriorated.

From a property owner/investor's point of view, one would typically want to see a strong market, which implies that demand is strong relative to supply of residential stock.

This relative shortage of residential stock would then lead to solid capital growth of the asset, a strong contributing factor to total financial return on one's property. Unfortunately, the past few years have not seen any meaningful capital growth, due to generally weak demand relative to supply.

In the past two quarters, the FNB Estate Agent Survey once again began to show estate agents perceiving strengthening housing demand, which may be largely seasonal as is customary in the summer season, but which may also be partly due to two further interest rate cuts by the Reserve Bank (SARB) late in 2010.

So, from an agent residential demand activity rating of 5.66 (scale of 1 to 10) in the 3rd quarter of 2010, the level has increased to 6.07 in the 1st quarter of 2011. The agents surveyed in the 1st quarter also reported a very significant increase in the number of viewers at their show houses that they perceived to be "serious buyers".

However, it has become interesting, with the agents surveyed simultaneously report a significant lengthening in the average time of homes on the market prior to sale, from a previous 15 weeks and 6 days to the 1st quarter's 19 weeks and 1 day, as well as an increased percentage of sellers having to ultimately drop their asking price to make the sale, from a previous 80% to 85% in the 1st quarter.

This may suggest that stronger demand has not yet led to an improved market balance, possibly because it is being matched by stronger supply of residential stock on the market. The evidence that we have of stronger supply is perhaps not yet solid, but there are signs. For one, our FNB Valuers as a group have on average been giving stronger supply ratings in their valuation reports in recent months.

As for the estate agents, after an increase in the percentage of survey respondents reporting "stock issues" (constraints) from late-2009 and through the winter of 2010, that percentage declined noticeably in the summer 2010/11 quarters, i.e. the 4th quarter of 2010 and the 1st quarter of 2011.

In addition, when examining the various reasons for selling, we sense that there is evidence of improved supply of stock coming to the market too. The evidence lies in the fact that agents have reported an increase in the percentage of what we call "selling for non-negative reasons". These reasons are "selling in order to downscale due to life stage (e.g. retirement or kids leaving home), selling in order to upgrade, selling in order to re-locate to elsewhere in SA (mostly for better job opportunities), and selling in order to move closer to work or amenities.

We believe that a greater portion of such categories of sellers are not in a rush to sell, compared to those selling in order to downscale due to financial pressure for instance, and thus are possibly more willing to bide their time, coming out of the woodwork in larger numbers when they perceive it to be a relatively good time to sell. Recently, a significant increase in sellers selling for "non-negative" reasons suggests to us that there has perhaps been an improvement in the confidence that sellers have in their ability to get their price, bringing an increased number of aspirant sellers out of their hiding places.

This apparent development on the supply side is all part of the long residential market healing process. One should expect that, after an improvement in demand there should at some stage be an improvement in seller confidence as well.

However, this event would also serve to slow the pace of return to a better market balance, with a better market balance ultimately being reflected in a significantly shorter average time of properties on the market along with a smaller percentage of sellers having to drop their asking price.

It would also be likely to delay the return of respectable growth to house prices. Such is the long slow nature of the residential property market recoveries - patience required.

Rising from the Rental Market grave.....

Data availability for the rental market is far less comprehensive than for the home buying market in South Africa. However, with what data we have it would appear that the fundamentals of the rental market may be improving, and this may lead to rental market strengthening in 2011.

During the property boom years, buy-to-let buying of residential property was taking place at a far greater pace, implying that the supply of rental stock coming onto the market was growing rapidly. This appears to no longer be the case. In the fourth quarter FNB Estate Agent Buy-to-Let Survey, buy-to-let buying remained at a lowly estimated seven percent of total buying, unchanged for the second successive quarter and a far cry from the estimated 25 percent back early in 2004.

This buy-to-let weakness comes as little surprise, with the household sector still under very significant financial pressure as well as being highly-indebted, while banks’ credit criteria remain conservative by the standards of a few years ago. This not only constrains the supply growth in rental stock, but also keeps a greater number of would-be first time home buyers in the rental market for longer than would otherwise be the case, thereby supporting rental demand.

In addition, very low house price inflation means that our property-related real prime rate (i.e. adjusting prime rate for house price inflation) remains positive (+5.4 percent in December 2010). This curtails the short term speculative component of buy-to-let buying, where buy-to-let buyers are more focused on profiting through short term capital growth on property outstripping interest rates. This form of buying is believed to have been far more significant during the boom years when at one stage during 2005 the property-related measure of the real prime rate was negative to the tune of -25.3 percent, a speculator’s paradise.

Low interest rates and growing economy = better quality of tenant

According to credit bureau TPN, there has been a broad improvement in the quality of tenants since early-2009. As at the first quarter of 2009, only 71 percent of tenants on TPN’s records were "in good standing". During the second and third quarters of 2010, this percentage has risen to 82 percent and 81 percent respectively, the highest percentages since back in the first half of 2008 prior to the national recession. Yes, many tenants, like home owners, were also affected by recession and high interest rates back then. The more recent apparent improvement in tenant quality also bodes well for an improvement in the rental market.

Rental inflation accelerating

Given the lack of supply growth in rental stock, and reason to believe that significant financial barriers to entry to home ownership exist at present, it came as little surprise that we started to see an upward turn in StatsSA’s CPI home rental inflation survey numbers. Done on a three-monthly basis, inflation in actual residential rentals rose from 4.5 percent in June to 5.6 percent year-on-year in the September survey. This represents a turnaround from a steadily decelerating rental inflation rate since back early in 2009.

The initial rental inflation rise nevertheless points to a still financially pressured household sector, with "smaller being better", and thus the fastest rental inflation acceleration took place in the flats category (8.6 percent, up from six percent). By comparison, townhouse rental inflation measured 4.4 percent, moderately up from four percent in the previous quarter’s survey while house rental inflation was virtually unchanged from the previous survey.

2011's rental inflation important for buy-to-let recovery

A lack of buy-to-let demand in recent years, especially through 2010, implying slow growth in rental stock, is crucial to our belief that we will see some acceleration in rental inflation through 2011. In addition, given our expectation that consumer price inflation will gradually rise further through 2011, after two successive months of increase late in 2010, it looks increasingly unlikely that the SARB will cut interest rates any further for the time being at least, and sideways movement in rates through 2011 is anticipated. This may put the brakes on first time home buying, keeping more would-be home buyers in the rental market and thereby supporting rental demand.

An expected rise in rental inflation in turn has two possible effects. Firstly, given very low expected house price inflation, we believe that gross yields on residential property will rise through 2011, and this is a key pre-requisite to larger numbers of investors returning to the market at some future stage. Secondly, however, it can have the shorter term effect of contributing to rising consumer price inflation which could ultimately mean rising interest rates (although Firstrand only expects interest rate hikes to commence early in 2012).

In the fourth quarter 2010 FNB Estate Agent Survey an increased portion of the sample of agents expected an improvement in first quarter 2011 buy-to-let buying. This drove the FNB Buy-to-Let Confidence Indicator slightly higher to 0.065 (scale +1 to -1) from a previous quarter’s low point of 0.045.

This is an interesting turn in estate agent sentiment after five previous quarters of deterioration. In our own opinion, any noticeable improvement in buy-to-let buying may take somewhat longer. However, we do believe that the fundamentals that ultimately drive the buy-to-let market (i.e. a stronger rental market and higher yields on residential property) should improve significantly through the course of 2011, setting the buy-to-let market up for strengthening at a later stage.