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Economic trickle-down reaches lower-priced homes

Thursday, October 5, 2006

While house-price growth in general continued to decline during the second quarter of 2006, the lower-priced section of the residential market grew at a faster rate than the middle and upper-priced sectors.

According to market data collected by Rode & Associates property valuers and economists, and analysed in the latest Rode’s Report on the state of the property market, between 2000 and 2005, middle-priced houses put in the best performance, followed by upper-priced and lower-priced houses.

But, Rode’s figures also show that since 2004, lower-priced houses started to outpace the more expensive suburbs.

“This can be ascribed to the fact that house-price growth has exceeded disposable-income growth for a number of years, forcing many buyers to scale down,” says Rode & Associates CEO Erwin Rode.

Rode says the increased activity at the lower end of the home market comparative to the other sectors, is also a sign that the trickle-down effect of the country’s economic growth is showing signs of seeping through to the lower income groups. Even prices in the townships and inner-city flats are doing well.

“It is a universal effect of economic growth that the upper echelons of society benefit first from growth before it starts to trickle down to the lower-income sectors. This is an encouraging sign for South Africa, and it is probably not a coincidence that employment has also started to rise”

The Report also indicates that the office market’s vigour is starting to show. While CBD office rentals were collectively up by 15% on a year earlier, decentralized rentals were only 7% higher. “Of course, the relatively stronger performance of the CBDs is from a much lower base (barring Cape Town CBD that is)”.


On the industrial front, the upswing in real rentals continued on the back of strong manufac-turing activity boosted by a weaker rand. Since the beginning of the second quarter, the rand has weakened about 16% against the dollar, allowing local manufacturers to capture a larger portion of domestic sales orders and increasing the export competitiveness of locally manufac-tured goods.

Industrial space in Pretoria once again showed the most robust rental growth of 42% during the reporting quarter, but industrial rentals in the Central Witwatersrand (17%), Durban (15%), Cape Peninsula (20%) and Port Elizabeth (15%), were also all notably up on the same period a year earlier.

Listed property income yields took a bad knock during the second quarter of the year as a re-sult of rising interest rates coupled with stock-market uncertainty.

A puzzling aspect of this poor performance highlighted by Rode’s Report, is the fact that most market participants are expecting robust income growth in the next year or more.

“Also peculiar is that listed property yields weakened further relative to bond yields. This seems to imply that investors felt that property was a bit overpriced relative to bonds,” says Rode.

The Rode’s Report team of analysts see all factors pointing to the fact that the down-rating of the listed property sector was a bit overdone – “the kind of short-term irrationality which is customary of the stock market”.

“This gives us confidence that as the strength of property fundamentals starts to show up in the bottom line, listed yields will strengthen again, even if not to the same lows that have been seen in the recent past,” Rode predicts.

Capitalization rates are expected to resist interest-rate hikes. One of the reasons given in Rode’s Report is that, despite the expected deterioration in short-term inflation, and the pros-pects of further interest-rate hikes, long-term inflation expectations are still positive. Further-more, with the market anticipating strong rental growth during the next few years, it is unlikely that cap rates will experience notable upward pressure any time soon. Capitalization rates are the property equivalent of the forward earnings yield of shares.

The worst that might happen, predicts Rode’s Report, is a decrease in the number of transac-tions by owner-occupiers and private investors who are generally more interest-rate sensitive than fund investors. There’s also anecdotal evidence that listed funds might be forced to curb their acquisition programmes in the face of higher finance costs.

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