Property prices: ‘you ain’t seen nothing yet’

Various supply and demand factors should ensure that property prices continue to rise.

Accelerating long-term economic growth in South Africa will stimulate the demand for property, while building capacity constraints will result in a shortage of supply, John Loos, a property strategist at First National Bank, told a recent property investment conference hosted by the Investment Property Databank (IPD) and the South African Property Owners’ Association.

If you think property is expensive now, “you ain’t seen nothing yet”, Loos says.

Periods of accelerating long-term economic growth, driven by structural change, are generally times of under-forecasting during which market booms exceed expectations, he says.

Loos says he was asked to comment on how six-percent growth in South Africa’s gross domestic product (GDP) would affect property, but he does not expect the country’s economic growth to achieve that level until early in the next decade.

However, he says, when projecting the performance of property, the rate of growth in the economy is arguably less important than its direction – and currently growth is accelerating rather than decelerating over the long term.

The direction is important because if a country comes off a low growth base, the construction sector lacks the capacity to provide property at an increasing pace.

After a very long slump in the construction industry during the 1980s and 1990s, there is limited capacity to keep up with the growing demand for property, Loos says.

The building and construction sector has been accustomed to economic growth of about nought to two percent, he says. Mounting material and skills shortages, as a result of considerably faster growth, are expected to drive double-digit inflation in building costs.

Major infrastructural projects planned by the government and for the 2010 World Cup will also cause building costs to escalate.

Building cost inflation is expected to drive up property prices, including the price of residential property. As a result, Loos says, the currently slowing residential property market has yet to see an end to the good days.

He expects a recovery in the residential property market in 2008, as he anticipates that by then interest rates will be decreasing again, to a turning point below last year’s prime rate low of 10.5 percent

In addition, Loos says, the growth in residential property spending among the emerging black middle class may out-pace the GDP growth rate. This is because as households move into higher-income categories they tend to increase the portion of their budgets that they spend on property.

For instance, on average, households in Randburg spend an estimated 12 percent of their total expenditure on accommodation, while households in Soweto, with a far lower per capita income, spend on average only 7.7 percent.

Loos forecasts residential property prices to have risen by the end of 2010 by an average 85 percent on their prices at the end of last year.

Although this is not nearly as impressive as the approximately 230-percent rise in property prices between the end of 1998 and the end of 2005, he says it will still be a significant increase.

Constraints in the construction industry have a lot to do with the current bullish views on commercial property, Loos says.

Already there is a mounting scarcity of commercial space, he says.

The best-performing sub-sectors of commercial property last year were retail and industrial, with average total returns of 33 percent and 33.1 percent respectively.

The office sector has been lagging (24.5-percent total return last year), Loos says, but is expected to accelerate towards a 30-percent return in the year ahead.

The vacancy rates of the different types of commercial property have been declining since 2002 and show little sign of increasing despite the fact that there has been significant building activity, he says.

This indicates that we are probably some way from an oversupply of commercial property, he says.

In industrial property, Loos says, low vacancy rates are driving strong rental inflation, with reports of year-on-year increases of between 12.6 percent and 42 percent. He says office rentals are also accelerating, with reports of rental inflation as high as 15 percent last year.

Loos says further acceleration in economic growth and constraints on the supply of property could result in average double-digit rental inflation for industrial and retail property by early next decade.

If commercial property rentals increase at an average rate of 10 percent a year, which is not unreasonable in an economy that is growing at a real rate of four to five percent, by 2015 rentals will have risen by 159 percent of 2005′s values, he says.

In addition to building supply constraints, Loos says the scarcity of land in metropolitan areas will become more problematic in the years to come and will impact positively on the price of property.

Loos says that because economic growth is accelerating, you can expect the upswings in property prices to be longer and more extreme, and the downturns to be shorter and milder compared with those in the 1980s and 1990s, when the economy was stagnating.

So, although there has already been a long upswing in property prices, you shouldn’t expect a sustained downturn yet, Loos says.

He says people tend to base their expectations for property on what happened in the 1980s and 1990s. It would probably be better to look back to the 1960s as a benchmark for property performance in an economy that is growing more rapidly.

(Persfin, November 4, 2006)