February 2011

There are some positives for the economy in that the growth outlook has improved, but GDP growth is expected to remain below potential over the next two years. According to the IMF, the SA economy is projected to grow by 3.4% in 2011, down by 0.1% from previous projections (3.8% in 2012). This is in line with the SARB, predicting 3.4 for 2011 (3.6% for 2012). This does not include the impact of unexpected shocks to the domestic economy due to possible set-backs to other economies spilling over to SA.

There has been mild increase in employment (1.8% y-o-y; Q2 2010), and interest rates are at low levels, last seen over 30 years ago (hikes are expected early in 2012, if not sooner). Household finances showed some further gradual improvement in 2010 on the back of stable interest rates and lower inflation, with household disposable income increasing after the recession, but still constrained at 8.1% year-on-year (Q3 2010). And, household affordability levels have improved, although this has not translated into higher residential demand (see the latest FNB Quaterly Residential Review for some possible explanations).

Although down from 82% in 2008, household debt remains in high risk territory at 78.5% of disposable income, and household finances are still not out of the woods. And, although improved from 2008, the household sector debt/service ratio is still high at 12.4%. These ratios are vulnerable due to escalating costs, such as Eskom (24% average annual inflation over the last 2 years), assessment rates and water, and interest rate hikes.

The recent slow-down in the economy has had an adverse effect on the net wealth of households. As a consequence, households have been consolidating their positions by focusing on building their “post recession” balance sheets. But, savings levels remain poor, meaning that households have little or no surplus funds when facing financial difficulty.

It is thus no surprise that the property market is feeling the pinch. After the boom a few years ago, property price growth slowed markedly, and dipped into negative territory. The first half of 2010 saw good growth, slowing during the latter half of the year. Most commentators are predicting a flat residential market in 2011. Jacques du Toit of ABSA expects an increase of 3% in nominal terms (7% was recorded in 2010), and a decline in real terms (assuming inflation of around 4%). John Loos of FNB is also reporting a slowing year-on-year growth rate, with average deflation of -1.2% being predicted for 2011.

Loos says that “the slowing year-on-year growth rate in the average house price remains largely driven by weak demand growth, which in turn is the result of, firstly, a weak economy and its constraining effect on household income growth, and secondly the high levels of household debt relative to disposable income. But strong residential supply, an overhang from the building boom of a few years ago as well as high levels of financial pressure-related selling, also plays a key role”. Another factor in the muted expectation is that the flat interest rate forecast for 2011 will have the effect of not providing further stimulus to the property market.

And, although banks have eased their lending criteria somewhat, it is still a constraining factor. According to ooba (December 2010), banks require a 14.8% average deposit (as a percentage of purchase price) from buyers, down from an average 18.3% in December 2009.  Effective approval rates have also increased from 59.6% in early 2010 to 67.8% by year-end. In addition, the ratio of home loan applications declined by one lender but approved by another increased 12.6% year-on-year to 29.2% in December 2010.

Weak demand is also evidenced by the average time on the market, 15 weeks and 6 days, according to the FNB Property Barometer (Quarter 4, 2010). This is a long period of time, compared to 2005/06, when average times were 2 months or below (notwithstanding this, sellers still seem unrealistic in setting prices, in that 80% have to drop their price in order to make the sale). Of those sellers who dropped their asking price, the estimated average drop was -11%, only slightly better than the -12% of the previous quarter.

Financial distress is highlighted by the percentage of sellers selling in order to downscale due to financial pressure. After 2 years of deterioration (increase), 2010 saw a drop in this percentage from 28% in 2009 to 20.5%. While significantly better, this is “still troublesomely high, still reflecting very significant financial pressure across the country”.

So, to what extent will distressed sales in the SA residential market continue this year? Put differently, are there still opportunities out there for investors wanting to sign up for our Property Partner Programme?

Distressed sales broadly include 1) properties sold prior to sales in execution due to financial distress 2) Sheriff sales in execution, 3) Insolvency and liquidation sales 4) Property in possession sales (this is where banks have "bought back" properties at sales in execution).

1. The number of properties sold prior to sales in execution is difficult to monitor as sales are made through various channels and because most information is not in the public domain. For example, auction houses have information on such sales, but meaningful information is not published. The same holds true for the banks. Some indication of the number of sales "within 31 days of a Sale in Execution notice" is gleaned, however, from the Lightstone graph "Outcomes of SIE notices becoming forced sales" displayed under point 2 below.
2. Sheriff sales in execution can be monitored by reviewing the number of sale in execution notices (SIE notices). According to Lightstone, from a peak of just under 30,000 notices per year in 2003 (the worst year in history), this dropped to just over 10,000 in 2006, before seeing steady increases until 2009 where numbers were again just under 30,000. 2010 saw a 16% decrease to around 25,000 per year.
   
   
   However, over the last 2 years or so, banks have been assisting homeowners to stay in their homes by offering debt restructuring, so decreasing the number of SIE notices. And, properties have also been disposed through rapid auctions and the banks facilitating deals between owners and estate agents. This has also lead to lower SIE volumes. In fact, there has been a concerted effort by the banks to limit the number of sales in execution, due to the time and cost involved, as well as the negative impact of low prices on them and homeowners. When the banks need value to be there, it is not achieved, as foreclosed properties sell for 20% to 40% less than market value.
   
   The number of SIE notices has to be viewed against declining volumes in the “normal” market, one of the clearest indications of pressure in the residential market. According to Lightstone’s analysis of Deeds Office data, the volume of transfers has come down from 35 000 per month in 2004/5 to around 10 000 per month in 2009. As a result the total value of transfers has fallen from R20bn per month to just above R10bn today, despite inflation. The total value of residential transfers through the Deeds Office in 2009 was approximately R150bn, down from R400bn in 2004. So, SIE notices have been increasing, whilst normal transaction volumes have been decreasing.
   
   According to Lightstone, in 2009, only 20% of the SIE’s actually turned into a forced sale. This means that only around 6,000 sheriff sales took place in that year. Lightstone defines “distressed period” as “sales within 31 days of a SIE notice”. During 2009, 45% sold “later than the distressed period”.
   
   
3. Insolvency and liquidation sales:
   According to StatsSA, the total number of liquidations for 2010 decreased by 3.4% (from 4 133 to 3 992) compared with 2009. A year-on-year decrease of 14.9% (from 382 to 325) was recorded for December 2010.
   
   The total number of insolvencies for the first eleven months of 2010 decreased by 32.2% (from 5 229 to 3 544), compared with the first eleven months of 2009. A year-on-year decrease of 28.7% (from 470 to 335) was estimated for November 2010.
   
   This implies lower numbers of residential property sales in 2011 as a result of liquidations and insolvencies.
4. PIP’s: In September 2009, Lightstone noted that properties in possession were below historical highs. It is common cause that PIP sales happen – on average – at a higher prices than Sheriff sales.

The above data paints a mixed picture, but does seem to indicate that we’ll experience less distressed sales this year. But, we’re not out of the woods yet, and it is expected that financial distress will still be at fairly high levels, resulting in distressed sales, in particular until household debt levels return to more prudent levels. And, as mentioned above, household debt levels remain vulnerable to household utility increases, and interest rates.

Given this outlook, YDL will still continue to focus on distressed sales, at least for the first part of this year, after which we will review the situation again.

These are people who got themselves properly educated and follow the simple, age-old rules of property success, during good times and bad. Prime among them is that income is far more important than capital growth. Concentrating on rental income rather than capital growth is not as dramatic as chasing capital growth but its compounding is what Albert Einstein is alleged to have called the “8th wonder of the world”. Anyone who has been receiving rental income from a property for more than 10 years will know exactly what we mean.

Although this is a buyer’s market, most “ordinary man-in-the-street” investors have fled the market, or can’t afford to get in (buy-to-let investments now only make up 7% of total purchases, down from around 25% a few years ago). This creates opportunities for professional, astute investors with know-how, or access to expertise such as YDL’s, to invest in excellent deals.

For investors buying properties the greatest challenge will be finding the cash for a deposit plus legal and transfer costs. This is because the banks are in most instances not granting 100% bonds as reported in our Outlook. And perhaps even more of a hinderance is that rents will rise too slowly to cover reverse cash flow quickly enough (rents are positively impacted by slow growth in buy-to-let stock due to lower levels of buy-to-let purchases, but negatively impacted by a higher portion of tenant disposable income going towards utilities). The low price and rent rises also mean banks will be reluctant to increase bonds to help cover reverse cash flow.

YDL’s Property Partner Programme, however, provides the perfect solution to the above dilemma. We assist buy-to-let investors to enter the market with either cash flow positive or neutral deals, so adding excellent investments to their portfolios. Although not part of the core strategy mentioned above, we are also helping investors generate quick capital by focusing on speculative deals, simply because the current distressed market allows for these deals. This strategy is particularly useful for investors wanting to build their capital base (many are doing so opportunistically, with the intention of putting such gains into buy-to-let deposits later on.)

The greatest opportunities remain the following:

1. Finding properties in good areas at higher initial net returns (yields) than one has been able to find in the past seven or more years. YDL wouldn’t buy for less than 8% forward yield in Sandton and would negotiate aggressively for 10% or more. In a “normal”market, this kind of deal is unheard of.
2. Opportunistically buying and selling properties, due the significant discounts we’re able to achieve when purchasing. This allows you to sell at below market levels, but to still turn a healthy profit
3. People who have established themselves in niches for some years will continue to pick up some great bargains. And for those who haven’t, its a time to choose your niche area or type of property and build your knowledge advantage and your wealth slowly but steadily.

If you are interested in generating wealth by buying at substantial discounts, and generating good cash flows, we urge you to join our Property Partner Programme now. Time is starting to run out given the relatively lower levels of distress, and – for speculative buyers - the long lead time between starting up, and earning profits from your purchases through resale.

YDL has a top quality team that does it all for you: The research, the buying, the renovations, the evictions, the sales. You don’t have to lift a finger. And, our expertise allows us to manage the risks.

Contact YDL now for a free consultation where we will explain how to join. Call us on 011 465 7356 or email us on info@ydl.co.za, or sms us on 083 389 0321, or click here for a free consultation.

Midrand
We last week bought a property in Midrand for R275,000. Once outstanding levies and rates were added, the purchase consideration came to R340,000. The market value of the property is R530,000, so the investor is immediately better off by R190,000, before transaction costs and fees.

The double-volume 1 bed unit is so popular that we let the property the same day for R4,000 pm. We were confident that we could achieve a higher rental, so improving the yield, but our investor elected to take the R4,000 pm offer.

Levies and rates come to R966.10 pm, therefore the property yields 10.7%. A rental of R4,500 pm would have given a yield of 12.4%. A 90% bond at an interest rate of prime minus 1%, will have monthly repayments of R2,275.

This gives a positive cash flow per month of R758.90 (the investor chose to manage the property himself; the rental is paid via debit order). At a rental of R4,500 pm, the cash flow would have been R1,258.90 pm!

Lonehill
This 4 bed 3 bath property in an exclusive estate was bought for R1.140m plus R40,000 arrears. We spent R120,000 in renovations, and have just sold the property for R2.15m, so netting our investor – after all costs, including transfer costs, holding costs, interest costs, agent costs, and YDL’s fee, R360,000, a whopping 77% ROE over just 9 months.

Watch a short video where Deon describes the property.



Contact YDL now for a free consultation where we will explain how we can help you to obtain similar deals. Call us on 011 465 7356 or email us on info@ydl.co.za, or sms us on 083 389 0321, or click here for a free consultation.

Case-study summaries

The FNB Quarterly Housing Review focuses on the key issue of housing affordability, and why residential demand has not grown significantly despite a very significant improvement in the two “traditional” calculations of affordability that are used. These measures are the average house price/average remuneration ratio and the installment value on a 100% loan on an average priced house/average
remuneration ratio. Both of the indices reflecting these ratios have fallen (improved) dramatically since their peaks in 2007/8, the price/average remuneration ratio by -22% and the installment/average remuneration ratio by -40.4%, with interest rates providing additional downward impetus for the latter ratio. However, these dramatically improved trends run contradictory to our FNB Estate Agent Survey results where an increasing percentage of agents (57% by the 4th quarter of 2010) are stating that income levels have got “far behind home price levels”. Despite the estate agent survey question requiring only a subjective and qualitative answer, our feeling is that their answer is far closer to the mark than calculations using average price and average remuneration. This is in part because of the major decline in formal sector employment from 2008-early-2010, according to the SARB as much as -15.4% over the period. Therefore, the average income earner may be fine, but formal income earners are significantly less in number compared with a few years ago.

However, the issue is more complex than that, because the question has arisen as to how come the likes of new motor vehicle growth far outstrips new home sales (and thus new residential building activity growth)? The motor vehicle sector operates in the same economy as the home market, and is also affected by issues such as recession and job loss. But new motor vehicle sales growth was robust through 2010 to early-2011 (as were retail sales), while the also interest rate-driven new housing demand (and thus building activity) remains virtually in freefall.

Here, the concept of “relative affordability” comes into play to partly explain the differing performances. During the last decade, prior to the recession, both the housing market and the vehicle market had huge demand booms, driven largely by a dramatic reduction in the cost of credit, a healthy economic and household income growth rate, and a far lower household sector level of indebtedness than today. However, the boom time rate of increase in house prices far outstripped that of vehicle sales due to a far greater limit in the supply of new homes to the market. The more severe supply constraint in the housing market is due to building sector constraints, whereas vehicles can be imported rapidly rendering the supply thereof virtually unlimited for a small economy such as our own. The result was that house affordability (price relative to income/remuneration) deteriorated far worse during the boom than was the case for motor vehicles, with vehicle affordability actually improving over the whole decade. This relative affordability deterioration in housing alone must surely have an impact on the relative performances of housing demand versus vehicle demand.

However, the possible reasons go even further. While many people think of home ownership as an essential item, the reality is that for the middle class it is not always essential in the short term. Or, at least, it is not always as essential as vehicles. By this we mean that would-be new entrants to the home market can often rent, or alternatively, delay their entry into property by remaining in their parents home for longer than perhaps originally planned. Mobility, however, is extremely important in the middle to upper income job market, and good public transport is not yet a reality. Private vehicles are thus arguably a more essential middle class item than owning a home.

Motor vehicles also have a shorter lifecycle than houses, meaning a shorter time to replacement. Therefore, one would expect this, too, to cause a more prompt recovery in vehicle demand once economic conditions improve or interest rates fall.

Back to affordability issues, and one must not rule out the impact of rates and utilities tariffs related to housing. These have climbed steeply in recent times, and the multi-year Eskom tariff hikes mean more of the same in 2011 and 2012, outstripping private vehicle related cost increases. Electricity tariff hikes are most prominent in this regard, but assessment rates and water are not far behind.

Finally, with regard to access to finance, it probably wouldn’t even be necessary for home loans banks to have tighter credit criteria than vehicle financiers in order to have a bigger negative impact on their market. The large value of a home purchase relative to car purchases (on average) mean that a 10% hypothetical deposit on a motor vehicle purchase would be manageable for more people than a 10% deposit on a house. Therefore, SA’s severe lack of savings militates far more against a big ticket item such as a home purchase than against items where smaller loans are required.

So, the affordability deterioration of housing relative to both vehicles and overall consumer goods and services (including the relative affordability deterioration contribution of big rates and tariff hikes), over the last decade as a whole, should imply the need for the household sector to re-balance its expenditure basket by reducing the portion spent on housing relative to other items. Many would-be new entrants can do this in the short term, due to the less essential nature of middle class home ownership relative to reliable motor vehicles. Hence, the ongoing decline in new residential building completions in 2010 in stark contrast to sharp growth in new motor vehicle sales. This rebalancing of the household sector expenditure portfolio, along with very weak job creation further hampering new entries to a market that still appears to be oversupplied, and given our expectation of no further interest rate cuts in 2011, leads us to the expectation of mild average house price deflation in 2011. We pencil in an FNB House Price Index decline of around -1%.

While there are no obvious indications of any significant stimulus for the market in 2011, at this stage there are fortunately no obvious indications of any sharp shock to the market either, just a very “flat” and unexciting year. Any “unexpected” shocks to upset the apple cart would probably emanate from foreign sources. What happens to the US economy after their huge stimulus measures wear off? Do capital inflows into SA reverse sharply, causing a sharp currency weakening and an inflation surge? Do global food and oil prices “spike” again? For the time being, though, the 2011 environment appears fairly benign, but with gradually increasing upward pressure on inflation, which in turn is expected to lead to interest rate hikes from early 2012.

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