Bleak outlook for house prices

Research by Wilhelm Hertzog, an equity analyst at fund manager RE:CM, suggests house prices will struggle to recover as they are still high compared with their historical average.

According to his data, South Africa residential property is not wildly overpriced (as was the case from 2005 to 2007), but is far from cheap.

"Working with data available to us, we can make certain inferences about residential property rental yields," said Hertzog. "To us, direct property ownership comes across as somewhat less risky than owning equity in a business, but somewhat more risky than lending money to a creditworthy borrower. This suggests that, over time, property should deliver investment returns somewhere in between that of equity and that of bonds."

According to Hertzog, using data sourced from Rode & Associates, South Africa investment property has, on average, returned a bit more than 5% (real, after inflation) since 1962. This level of return fits neatly in between the real return of about 7% achieved by listed equities and the 2% real return delivered by bonds in South Africa over the 111 years to the end of 2010.

Hertzog said residential rental yields in South Africa are, on average, in the vicinity of 6% at present.

However, Erwin Rode, the founder of Rode & Associates, cautioned that the 6% yield is actually the gross income yield and does not take into account maintenance and other costs.

"The actual net income yield is as low as 4%-5% in metropolitan areas. It might be higher in the platteland (small rural towns), but that is because the outlook there is more uncertain," said Rode.

"This suggests that house prices are still overvalued and we will be seeing real declines over the next few years. So if you're in the market to buy a property in the hope of capital growth, this would be a bad time to do so."

John Loos, FNB property strategist, said it was hard to use historical data to measure current house prices, as a lot depended on the starting point.

"If I started the comparison in 1994 and plotted the relationship between house prices and household incomes, then the current prevailing prices would have looked very high and overvalued. However, if I had put 2006 as the starting point, surely we would have seen that house prices at the moment are really depressed," said Loos.

He agreed with Hertzog that a sustainable recovery in prices would be a long time coming.

"If our economy was growing at 10% like China, then I would say that housing prices will recover imminently. However, with South Africa's economic recovery as anaemic as it is, it will be a long time before prices recover sustainably. Debt to household income levels are still elevated. They need to come down to below 70% at least.

"In my opinion this will only happen after the next interest rate hiking cycle, when rates start falling again. In all probability, house prices will start rising again strongly in the second half of this decade."

All three experts agreed that South Africa is unlikely to see a recovery in housing prices in the short to medium term.

Hertzog said: "The unfortunate news is that it does not look to us like now is a good time to buy South African residential property yet. Given the duration of the typical property cycle, it seems like there may be some waiting to do still."