JOHANNESBURG – The current uncertainties surrounding the land issue and emerging market woes – yes, a perfect storm – forced the yield on South African long-term bonds higher due to selling pressure by foreign investors.
The 10-year government bond index’s yield to maturity is a very good leading indicator of where lending rates are heading and is trading at around 9percent.
The gap between the 10-year government bond yield and the repo rate – the rate at which the Reserve Bank lends money to commercial banks – has widened and is indicating that, unless the perfect storm subsides, the repo rate could be hiked by 0.5 percent to 7 percent. The consequences of that are that you will pay more for all your debt.
The rate that you pay on your overdraft and mortgage bond at the bank is likely to increase by 0.5 percent to 10.5 percent.
As Joe Soaps of the world, mortgage loans probably make up most of our debt and assets.
While South African house prices as measured by the FNB House Price Index performed in line with the South African stock market as measured by the FTSE/JSE All Share Index since November 2013, storm clouds are setting in on the house market.
Apart from the perfect storm as mentioned earlier, it is now official that we find ourselves in a recession, and things are not looking good.
You will find it much tougher to borrow money from the bank as they will tighten their lending standards, if they are not doing it already, to limit defaults and to protect their interest margins. What I am saying is that residential property prices are likely to come under pressure. You may have time on your side, whether you are a first-time buyer or if you are planning to switch to a higher valued or “better” residence.
However, make sure that you can stomach the negative impact on your cash flow should lending rates jump by 1.5 percent to 2 percent. If you are a seller, be realistic in your asking price, especially if you already committed to buying another residence, otherwise you may have double trouble – paying for both properties. If you are planning to buy an additional property or want to increase your own real estate portfolio to rent out for income you should think carefully and also look at alternative property investments outside the residential arena.
House prices as measured by the FNB House Price Index have outperformed Growthpoint (my trusted stalwart in the listed property sector – given the uncertainties surrounding some of the listed property constituents) since 2012, mainly as a result of higher capitalisation rates required due to rising long-term bond yields locally.
According to Reserve Bank data (Second edition 2017 – Financial Stability Review), the average price-to-rent ratio from January 2012 to June 2017 was 14.7 times, and was pretty steady around that level. If it is assumed that the ratio is in the same vicinity it translates to an income yield of 6.8percent.
Currently stalwarts such as Growthpoint are trading at a dividend yield 8.3 percent. Most of the listed properties are well diversified and cover industrial property, office blocks, shopping centres as well as offshore real estate assets.
If you want to gear up and take advantage of the relatively high-income yields of listed properties, the current gap between mortgage rates as measured by new mortgage loan rates charged by banks for dwelling units and the dividend yield of a listed property stalwart such as Growthpoint is about 2 percent – approaching the lowest gap of 1.5 percent since 2009. What it means is that an increase in mortgage rates is already priced into Growthpoint’s price. The upper end of the yield gap range since 2009 was about 3.75 percent.
Another big advantage of investing in listed property is that your investment can be liquidated almost immediately.
Obviously, if there is something suspect about a company and its listing is suddenly suspended on the stock exchange, you are stuck with it, and it may take years to sell the shares, and most probably at a significant loss. In the case of direct property, your investment may be in the market for a lengthy period, especially if the property market is weak. The rental yield is influenced by the type of property, location and other factors, such as service fees and property taxes.
Investment in listed property is highly sensitive to movements in long-term interest rates. Should the 10-year bond rate increase by 100 basis points from 9 percent to 10 percent, the potential capital loss on an investment in Growthpoint is 25 percent, while a 100 basis point decrease to 8 percent could result in a capital profit of 19 percent.
Whatever you want to do, firstly make sure that you can afford a possible hike in mortgage rates and involve your financial adviser and other professionals if you are considering to buy to rent out, or invest in listed property. Perhaps I’m of the old school, but I believe that a roof over your head is not an investment - it is a non-negotiable that you must have. You can borrow against it, you can rent it out, etc - it is a store of wealth and dignity.
Buy or rent? It depends on your taste and financial health.
Ryk de Klerk is an independent analyst: contact [email protected]
The views expressed here are not necessarily those of Independent Media.