Walkers Attorneys

Property is the new buzz word on the mouths of most investors. At every social function at least seven out of ten people are playing the property game. Some are speculators, developers, first time buyers or those in the buy-to-let section of the property market.

Questions arising regarding the property market include whether property is the best game in town and why is it so popular?

To help provide answers we should step back in time a few years to get some perspective. Ironically, property was a dirty word in the world of investing a mere six years ago. The advent of the Russian and Asian crisis sent local interest rates soaring and owners saw the prices of their property assets fall dramatically. Even before that crisis, prices of property in regions like Gauteng had been falling year after year. Assurance companies, who till then had been by far the largest owners of property in South Africa, were reducing the size of their property portfolios in search of better returns elsewhere. Around that time it was almost cheaper to buy property than to rent.

Property was available at bargain prices yet no one wanted to buy an asset that had fallen in value each year. Sounds familiar! The "smart" money was being invested in shares, particularly small-cap and technology shares. The talk at social functions was about how much money people were making from IPO’s (initial public offerings). Another flavour of the time was global diversification. A few years later and what were once the darlings of the investment world are now the proverbial black sheep of the family. But this could never happen to property? Or could it?

Property is merely another asset class such as shares, bonds, commodities etc. All asset classes have cycles which implies that there are periods of time when they surge in value ( are in favour ) and fall in value ( out of favour ).

So why has property, especially residential property, had such a phenomenal run over the past three years?

We believe it is due to a number of factors namely:-

The dramatic fall in interest rates which is the fundamental reason for property having re-rated. It stands to reason that if the cost of owning property is reduced the demand and hence the price of property goes up. The Prime rate has more than halved over the past six years making it a lot more affordable for people to own property. However, this excessive demand can bring about problems of its own which we will discuss in this article.

The bursting of the Technology bubble in March 2000 and the subsequent negative sentiment relating to equities ( shares ) the world over.

Additional losses to equities were sustained the following year as a result of September 11. This already dire situation was further exacerbated in 2002 by the Enron and other similar debacles. The outcome was that global equity markets produced double-digit losses for three straight years resulting in investors losing faith in equities as an asset class. Hence money that might have been invested in equities went into "hard" assets such as property. With central banks reducing interest rates regularly to help stimulate their economies, property became more attractive and cheaper to acquire. The US Federal Reserve reduced its Feds fund rate from ±6.5% in 2000 to less than 1% over the period of only three years. That’s dramatic!

Back home, another positive has been the tight control over fiscal and monetary policy. This has helped South Africa to reduce inflation and provided a stable financial environment in which investors feel confident to invest in the country and hence into property.

These are merely some of the factors which have helped to create a positive sentiment towards property. Yet, has this sentiment become too positive? Are we creating a bubble in the property market?

From a fundamental perspective, if property continues to escalate in double digits, the answer is Yes.

Property is interest rate sensitive as we have seen and the re-rating in value has been justified as interest rates have halved. However, the majority of the interest rate decline has already occurred. It is unlikely that interest rates will halve from current levels and so there is little to support residential property doubling over the short term from current levels.

Further, developers have climbed on the bandwagon in response to the increased demand for residential property. With the proliferation of new properties coming onto the market, there is likely to be an oversupply of residential property in the next 12 to 18 months. This could hit the buy-to-let section of the property market in a big way. The problem with a bubble-like demand for property is that it continuously raises the price of property as everyone participates in the feeding frenzy. Most investors are attracted by the double-digit returns they have made of late on the properties they bought during or before the re-rating and expect the party to continue indefinitely. It no longer seems to matter about the holding or transactional costs of the property because there is a belief that it can always be sold at a profit! Hence the demand remains high and prices continue to rise until something goes wrong.

Most property optimists will no doubt gasp in disbelief. "What could possibly go wrong", they might say "the market is still undervalued by international standards;" "there is a new emerging market for property"… it sounds ominously similar to when tech shares were booming. The optimists found numerous reasons to justify why the tech market would continue to boom as this time things were different. They seldom are!

The reality is that things do go wrong and often at a time we least expect them to.

Maybe there will be an oversupply of property and tenants become scarce. Rental incomes could be squeezed. Owners may find they cannot afford to subsidise such properties and could become forced sellers. This in turn could lead to property prices reducing.

What if the Rand had to weaken materially resulting in the importation of inflation. A rise in interest rates would increase the holding costs of property without owners necessarily being able to pass such costs on to their tenants. This inflationary pressure could even come from government’s new focus on growth and delivery in the local economy.

It could come from some exogenous shock that we have not even contemplated. It often does. Like the unforeseen Russian and Asian crisis it could be a China or USA incident this time! As property investors you will know the saying ‘ caveat emptor ’ ( let the buyer beware).

Our conclusion is that property is definitely an important asset class in any well-diversified portfolio. However, it is merely one of many asset classes. Property, especially residential property is not cheap. Acquiring property now as an investment increases the risk to your portfolio. There seems to be more downside than upside potential in the short to medium term, so be cautious. As a prudent investor resist getting caught in the euphoria of doing what everyone else does. Don’t follow the herd. Ascertain what makes common sense and seek the investment opportunities that are not the flavour-of-the month. This is often the asset class that will become the new topic of conversation at future social functions.

Guy Antonier (B Com AFP) is the MD of Walkers Financial Services, a separate joint venture company owned by Walkers Inc and Guy Antonier. Guy is a licensed financial advisor with over 14 years of experience in the banking and investment world. He provides independent investment advice to our clients. Guy can be contacted on email at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or by telephone on 021 4620369.