Commercial Property recovery?

State leasing contracts may give property investors a reliable cash flow, while sales of distressed commercial properties may mean that bargains can still be found.

The South African commercial property market is showing signs of recovery in the coming year with certain areas offering reasonable prospects for higher profits, claims Mergence Africa Property Fund.

“There is a cautiously positive outlook for investments in commercial property in South Africa with a number of bright spots around the country offering the potential for higher-than-average returns for investors,” claims Mergence’s Izak Petersen.

He says that property owners with the right black economic empower credentials will benefit from leases from government departments and state-owned enterprises. “These leases represent a low risk in the testing economic environment,” says Petersen.

He says that property investors need to have a mix of government and national corporate tenants in their portfolios as these contracts improve the cash flow reliability, which is essential for property investment.

“Government tenancies put investors in the beneficial position of being default-free,” he says.

Referring to the risk profile, Petersen points out that corporate downsizing and the growing number of liquidations have boosted the rental default levels and when this is combined with higher municipal and electricity charges it makes the commercial property market challenging.

“For those property funds looking to acquire new properties, the increase in distressed selling may mean that bargains are available and could lead to more quality stock coming into the market,” he says.

According to the latest SAPOA Office Vacancy Survey, prime office space in Johannesburg and Cape Townwas either fully let or had vacancy levels of less than one percent.

Timing is Everything !

Seasonality is a well-established phenomenon in the global property market and, although it follows a different time frame, it is also clearly evident in the local property market. Seasonality essentially refers to changes in sales volumes and sales prices during the same calendar month from year to year, that reveal a similar magnitude and direction.

This seasonality is caused by natural factors such as the weather, administrative dates such as the beginning and end of the school year as well as social, cultural or religious traditions which include fixed holidays such as Christmas.

"Regardless of the overall trend in the property market, or the specific phase of the property cycle in a certain sector of the market, the property market displays seasonality, with higher prices driven by increased activity at certain times of the year. In South Africa, during the spring and summer months, sales activity increases and, as a natural consequence, property prices are firmer on the back of this increased demand. The effect on prices may not always be remarkable – but the effect on sales activity is often quite noticeable," explains Adrian Goslett, CEO of RE/MAX of Southern Africa.

He adds that two seasonal factors are at play during our spring and summer months.

"Firstly, the summer brings lush gardens, green grass and colourful flowers, and this certainly goes some way to create a favourable first impression among potential buyers. Secondly, the school year in South Africa runs from mid-January to early December, and families planning to relocate always prefer to do so at the end of the year to allow the children to complete a school year at one school and to start afresh at a new school at the beginning of the new year," he says.

But seasonality extends further into other sub-sectors of the market.

"In the student accommodation sector spring brings an increase in activity as students going to university in the new year look for accommodation and those who have completed their last year of study move away. While many people are on holiday in December, this does not detract from the seasonality of property sales during the summer, but simply shifts the locus of the seasonal upswing to the coastal and holiday towns in the country," comments Goslett.

Seasonality is not simply a phenomenon of interest to estate agents; it also has implications for buyers and sellers. Prices may not boom during the seasonal upturn during the spring and summer months, but the average percentage by which a seller needs to reduce the asking price to achieve a sale may be noticeably lower than in the winter months. This reflects the increase in potential buyers during these seasonal peaks, and more buyers mean a better chance of selling the property at a higher price.

Buyers and sellers who understand the seasonality of the property market are able to make better informed decisions. For example, buyers looking for student accommodation may find few available properties in April when all available student accommodation is fully occupied, but may be able to acquire such a property at a better price at the end of the year when more properties become available as students complete their studies.

"Understanding the seasonality of the property industry allows buyers and sellers to maintain a longer-term perspective on the immediate state of a specific property sector. Sellers considering taking a property off the market just before the summer holidays could well miss a sales opportunity given the uptick in interest during this time. Similarly, buyers should bear the seasonal factors in mind when making an offer on a property, particularly in areas where the effect of seasonality is particularly evident, such as in coastal towns and other holiday destinations," concludes Goslett.

Positive sentiment for the Buy-to-Let Market

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 4th quarter FNB Estate Agent Buy-to-Let survey, buy-to-let buying remained at a lowly estimated 7% of total buying, unchanged for the 2nd successive quarter, a far cry from the estimated 25% 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% 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, where at one stage of 2005 the property-related measure of real prime rate was negative to the tune of -25.3%, a speculator's paradise.

Lower interest rates and a growing economy (albeit mildly) may have also brought about a 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 1st quarter of 2009, only 71% of tenants on TPN's records were "in good standing".

During the 2nd and 3rd quarters of 2010, this percentage has risen to 82% and 81% respectively, the highest percentages since back in the 1st 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.

Not surprisingly, therefore, StatsSA rental estimates have started to show a rental inflation acceleration.

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 3-monthly basis, inflation in actual residential rentals rose from 4.5% in June to 5.6% year-on-year in the September survey. This represents a turnaround from a steadily de-celerating 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%, up from 6%). By comparison, townhouse rental inflation measured 4.4%, moderately up from 4% in the previous quarter's survey, while house rental inflation was virtually unchanged from the previous survey.

Rental inflation rise in 2011 will be important for an ultimate recovery in buy-to-let demand.

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 2 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 1st 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 2 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 4th quarter 2010 FNB Estate Agent Survey an increased portion of the sample of agents expected an improvement in 1st 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 5 previous quarters of deterioration.

In our own opinion, any noticeable improvement 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.

*John Loos is a strategist at FNB Home Loans

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.

Where are we in the Property Cycle?

As 2011 kicks off Adrian Goslett, CEO of RE/MAX of Southern Africa, takes a look at where South Africa’s property market is in the property cycle and what this means for homebuyers and sellers…

Cycles, a well-known phenomena in the world of economics, are evident in all economic sectors including the property market. These cycles are predictable long-term patterns that can be divided into three distinct stages known as boom, slump and recovery.

"The cycles are predictable in that booms are followed by slumps and then by a market recovery, which gives rise to the next boom as the cycle continues. The stages in the cycle are driven by various factors that affect the supply and demand equation in a particular market. In the property market, for example, supply and demand are driven by factors such as the interest rates, consumer debt-to-income ratios, the affordability of property and consumer confidence, among others," explains Goslett.

However, while predictable, these cycles are rarely regular, since the length and depth or intensity of each stage within each cycle are influenced by the particular confluence of driving factors and their effect on supply and demand.

The current property market cycle in South Africa provides a very clear example of how various factors determine the cycles.

"We experienced an unusually intense boom in the mid-2000s, with demand driven by a rapidly growing middle class with access to easy credit at low interest rates during a time of exceptional economic growth in South Africa. Property price inflation reached a peak of almost 25 percent, property sales were brisk and property development was robust. But in 2006 an unusually intense slump driven by an unusual confluence of factors emerged. Interest rates rose sharply, the implementation of the National Credit Act constrained lending and inflation soared as we entered a global and local recession, which negatively affected consumer confidence," notes Goslett.

As a result of the confluence of all these driving factors it became increasingly difficult for homebuyers to obtain credit and homeowners faced severe financial difficulties in meeting their financial obligations. Many of these overstretched homeowners tried to sell their properties and this, combined with the robust property development during the boom, created an oversupply of properties in certain sections of the market.

"This, coupled with the decline in demand driven by tight credit and affordability issues, saw the market enter a slump in which sales activity, house price inflation and new development slowed," explains Goslett.

However, recovery after a slump is inevitable.

"We have already seen the interest rates drop to historic lows, which, along with inflation back within target range, have also boosted general economic recovery. Lower interest rates, improved general economic conditions and the correction in house prices to more realistic levels have all led to an improvement in affordability. Sales activity is increasing as the banks slowly and cautiously start lending again, evidenced by improved approval rates of home loan applications. The supply and demand equation is beginning to balance again as the constraints on demand are lifted and already a shortage of properties is evident in certain areas. Given these realities, the South African property market appears to be firmly in the recovery phase of the cycle," comments Goslett

What does the property cycle mean to homeowners and potential homebuyers?

It is widely believed that the property cycle is a tool for "timing" an investment in property.

"That said, buying at the height of a boom and selling during a slump can result in a disappointing return on investment," says Goslett. He adds that the real fundamental lesson from the property cycle is that property is a long-term investment. "Excellent property returns are often only achievable if the property is held for at least a full property cycle, which generally stretches over seven to 10 years in South Africa," he says.

He says that while we are in for what may well be a long and steady recovery phase, property investors and homeowners can take comfort in the knowledge that the slump seems to have passed.

"Hence, we can expect a boom to follow. Although the boom is unlikely to be as intense as that of the early-2000s, it is sure to follow and will reveal to those who have held onto their properties during the recent and exceptionally tough slump phase that an investment in property remains one of the best long-term investments anyone can make," concludes Goslett.

The PROS and CONS of transferring Property from a Trust to your Personal Name

A significant new tax break which was granted by the South African Revenue Services on October 31 this year allows those whose residential properties are 'held' in companies, close corporations or trusts to transfer them, free of income or capital gains tax or transfer duty, into their own names or those of their beneficiaries.

The new law allows greater flexibility about the choice of the beneficiary - and it can be made use of until January 1 2013.

This new ruling should be made use of by as many people as possible because there is no logic in sticking to the old holding entities.

To hold a property in a trust, a close corporation or a company will automatically result in its eventually being taxed higher on capital gains when sold than if it were in the individual's name.

Furthermore, no concessions will be made for it possibly being the owner's primary residence. If the property is the owner's primary residence and is registered in his name, the first R1.5m will be exempt from tax.

The advantages of accepting individual ownership have been reinforced from the start of this year by the government's instituting an annual levy for the continued establishment of corporate entities. This could add significantly to the annual holding costs of such entities.

Under the amended law the person taking ownership of the property from a company must have lived in and used it primarily for domestic purposes from or before 11th February 2009. Furthermore, he must still be living there.

The beneficiary must also be a 'connected' person in terms of the Income Tax Act. This means that the owner himself and a relative must together have at least 20% of the holding company's shares.

If the property is being taken over from a close corporation, the other owner/partner can be another member of the close corporation or a relative of such a member - but in all cases the transfer will become invalid if steps are not taken to wind up, liquidate or de-register the company or close corporation within six months of the transfer of the property.

Similar rules apply to property transferred from trusts, but there the 'connected persons' concept has been extended to apply to any beneficiary of the trust or a relative of that person.

Where the original holding vessel has a more complicated structure, provision is made for unbundling this.

For example where a property is owned by a company, a close corporation or a trust, which is in turn owned by another corporate identity, or where the shares in the company are owned by a trust the beneficiaries of which live in the home, the new law again allows for the free transfer of the property from the company to the trust and then from the trust to one or more beneficiaries.

Again, the person to whom the property is transferred must have been using it as his primary residence for the stipulated period to qualify for the capital gains tax exemption.

Although the tax savings of a transfer to individual ownership are significant, the conveyancing fees will still be payable, as on any normal residential property transaction.

Furthermore, if a property is bonded,, the costs of cancelling the bond and registering a new one will have to be allowed for. It is possible that the new owner under today's stringent National Credit Act restrictions might find himself unable to raise a bond of the same size as the original - he might even be refused any bond.

This matter should be looked into before the transfer is affected.

*Lanice Steward is MD of the Cape Peninsula estate agency Anne Porter Knight Frank