South African Property: Rent or Buy?

The news that South Africa has now been included in the BRIC group (Brazil, Russia, India and China) can only mean good news for property investment.

According to Maite Nkoana-Mashabane, South Africa’s Minister of International Relations and Co-operation, the inclusion, “legitimises South Africa as a future global power and as an investable country - bolstering its position as Africa’s gateway and champion.”

According to the Sage Property Report from Standard Bank in September 2010, “confidence in the South African property market is returning”.

This is confirmed by the 8.3 percent year-on-year growth rate in the median property prices in August and 7.3 percent year-on-year in July and has given rise to the prediction that the average nominal growth will be around 6 percent for the year.

So is this the time to buy? Herman Slabbert, from Ronnie Matthews Estates in Cape Town says, “The answer whether to buy or lease depends on the profile of the buyer and to what extent current market conditions dictate or influence the choice (or limit the options).

“For an investor the question may be to either invest in the share market or property or both, but after the good bull run of worldwide equity markets the past year, share analysts warn of a dangerously over-bought market and that investors should expect a medium to large correction in the near future.

Rent

Buying is naturally the preferred choice for someone or a couple starting out, but the credit crunch and resulting stricter lending criteria of the banks makes it difficult to get loans, unless you can put down a substantial deposit.

The irony for the first time home buyer is that interest rates are at their lowest level in 30 years and home prices are at very attractive levels compared to the property bubble before 2008.

One strategy proposed is to rent and then invest or save the difference between the rental payment and the monthly bond amount one would have expected to pay, in the share market. These ‘savings’ though must to be invested in the stock market. In 10 to 12 years there should be enough accumulated capital to buy a house.

Buy

Michael Bauer, General Manager of property management company IHFM,says, “The biggest resistance to buying versus renting is the mental block caused by short-term thinking. People ask themselves why they should buy when they can rent for 30 to 40 percent less than their monthly bond repayments. They are also not responsible for repairs and maintenance and can move on whenever they feel like it.

“However, the fact is that monthly rental will generally rise by 8 to 10 percent per year and by the time the property owner has paid off the bond (are debt free) the rental will be about ten times more than it was 20 years earlier when they decided to buy not rent.

“In contrast, property owners will find that their bond repayments will no longer be a major burden and will probably be less than 15 percent of their gross salary. In essence, if you pay a deposit of 20 to 25 percent on the property, it makes sense to anybody to buy.

“If you compare for example a R400,000 bond issued at an interest rate of 11 percent, the property owner would pay around R990,000 in capital and interest over 20 years, but would own an asset worth R1.06 million.

Bauer continues, “The tenant starting with a rent of R2500 a month (subject to annual increases) would at the end of 20 years find that his total rent payments have been about R1.7m. However, there would be no asset to show for his outlay.

“Rental escalations and capital growth are usually far above annual adjustments to income so it will become less and less affordable to rent in future if you continue living in an area of your choice. When you retire of course and your income is reduced by 30 to 40 percent, rental may be prohibitively expensive.

“For the buyer or investor who qualifies financially to buy, there are many options available in the market. Remember it is still is a buyer’s market coupled with the low interest rates, notwithstanding mediocre capital appreciation expectations. For the shrewd/smart investor who knows the market and the product there are opportunities in the buy to let market.”

Buy to let

Slabbert says, “Recent activity shows a positive sentiment in the buy-to-let market, which is an important segment of property investment.

“According to a report in the Financial Times (in the UK), banks in London have for the first time started to give loan packages, one of up to 85 percent of the value of the property. (Coincidentally it is a subsidiary bank of Investec, the South African bank).

“However, one dilemma for the South African buy-to-let investor is stock. Since 2008 banks and other financial institutions have ceased to provide funding for new developments, resulting in supply constraints – limitations on the ability to deliver new developments. However, the supply constraint also has benefits.

“It must also be remembered,” says Slabbert, “that a market or area where supply is constrained generally will have higher rent levels, greater rent growth and higher capital values.

“The investment strategy focusing on supply constrained areas could potentially provide more durable income and stronger capital appreciation.

“As an example, one can look at the Atlantic Seaboard in Cape Town and then at a specific area like Camps Bay/Clifton area which is considered the most expensive real estate in South Africa has a legal as well as geographic supply constraint.

“In essence local government zoning for development is restricted and geographically there simply is not any scope for extending this area.

“Lastly, local opposition to development is fierce; the Camps Bay rates payer association plays an activist role to monitor any proposed developments and take action where necessary,” Slabbert concludes.

Interest rates, investor confidence in a stable economy, high growth prospects together with some incredible bargains in the real estate market make this a good time to buy if you are able to and reap the rewards over the long term.