After several years of successive growth, South Africa’s real estate sector felt the full force of the global economic crisis in 2008. The industry has been no more able to avoid the economic shockwaves than its counterparts around the world. Although the 2010 FIFA World Cup offered some respite, 2011 has seen a downturn and little appetite among investors for property. Caution is the current watchword. However, short-term tentativeness is offset by a general belief in the industry that the long-term outlook for the sector is robust. The same underlying principles of demand that drove the sector forward for much of the first decade of the 21st century still exist and should present strong growth potential over the coming years.

PRICE GROWTH: In the post-apartheid period, property has been one of the country’s success stories. Between 2000 and 2007, house prices increased by 253.7%, according to Global Property Guide. These staggering growth rates have been stimulated by several demand factors, including increasing social mobility, a favourable taxation regime and strong credit growth.

Despite an ebbing population growth rate, which fell for the 10th consecutive year to 1.1% in mid-2011, according to Statistics South Africa, the country’s young, and increasingly affluent, population has been driving demand for housing. As of mid-2011, 60.2% of the country’s population was under the age of 30, according to Statistics South Africa, suggesting that demand for property should remain strong for some time.

The country’s sustained economic expansion has also augured well for the real estate industry. Between 2000 and 2006, the average real GDP growth was 4% while the real disposable income increased by an average of 4.7%. This has had a significant impact on consumer potential and increased the pool of potential homeowners. Neil Gopal, the CEO of the South African Property Owners Association, said, “A few million people have moved into the middle class post-apartheid.”

SOCIAL MOBILITY: According to the South African Advertising Research Foundation’s (SAARF) Living Standards Measure (LSM), which calculates the socio-economic status of South African consumers aged 16 and above, there has been significant social mobility, with more than 60% of the adult population in the middle class in 2009. Emerging consumers, who have an average monthly household income between R2582 ($316) and R6090 ($745), make up 15% of the population, while established consumers, who have an average monthly household income of R9644-R27,647 ($1180-3384), make up 23% of the overall population.

Divided into 10 segments, with segment 10 representing the highest-income group, the LSM shows a rapid growth rate in all segments from five and above for the 2004-10 period. The highest growth rate, at 38%, is segment six, for households with an average monthly income of R6090 ($745). While there was a decrease in these rates in 2009, several higher-income brackets began to show growth again in 2010.

RISING INCOMES: This is not only good news for the residential sector, but also benefits other segments of the industry and for retail developers in particular. While the country’s economy has slowed considerably, with GDP rising by a modest 0.4% in the third quarter of 2011, consumption and investment are driving growth, rising by 0.9% and 1.4%, respectively, according to the economic forecasting consultancy Oxford Economics. Although the unemployment rate has been fluctuating, and is likely to worsen in the next year, the agency forecasts consumer spending will increase by 2.8% in 2012 and 4.7% in 2013. This is likely to be supported by a continuing upward trend in disposable income, as remuneration in the labour force continues to rise. Average wage settlements grew by 7.7% in the first nine months of 2011, significantly above the average headline consumer price inflation of 4.7%.

Several companies are interested in tapping into the potential of these emerging consumers. Positioning new developments is key to this as transport costs make up a large percentage of the budget for many South Africans. According to Samuel Ogbu, the CEO of Liberty Properties, “Hubs close to or within townships and hubs that are easily accessible will be profitable. New economic nodes outside traditional urban centres but close to a large number of people – I see this as a market that has a lot of potential,” he told OBG.

The market is benefitting from the growth in urban middle-class consumers, a fact reflected in the emerging property supply and prices. Andrew Golding, the CEO of Pam Golding Property Group, told OBG, “Today is a great time to buy. The residential market in South Africa has two distinct markets. The metropolitan first-home market has solid reasons for buying and selling, and is not dependent on speculation. It’s a young population, so demographic factors bode well and the fundamentals of a strong market are there.”

BUILDING APPROVALS: In the first half of 2011, building plan approvals by local authorities for new houses, flats and townhouses were up some 20% year-on-year (y-o-y), with most growth coming in houses smaller than 80 sq metres, flats and townhouses. This suggests a move towards affordability and higher density in the market. Indeed, in the second quarter of 2011, affordable housing, designated as units below R480,000 ($58,752), saw the second-biggest quarter-on-quarter growth (1.2%), just behind existing builds in the middle-income segment (2.1%), according to Absa Home Loans. In an analysis for the “Financial Mail Property Guide 2011”, Jacques du Toit, senior property analyst at Absa Home Loans, wrote, “Higher-density residential developments are expected to be a strong focus of future housing demand and supply. This will be driven by the affordability of housing, which will depend on building costs, the state of household finances, the cost of mortgage finance, and the availability and cost of vacant development land and municipal services.”

INFRASTRUCTURE BENEFITS: This suggests plenty of potential for developments targeting populous urban centres. Much of this – and the subsequent price pressure – is location-sensitive, with infrastructure development driving the market. According to Gopal, “As a result of the World Cup, a lot more infrastructure has been developed. We’ve been left with a significant amount of new infrastructure and in places like Rosebank and Sandton [in Johannesburg], it has changed the nature of business.” The main example cited for this phenomenon is the Gautrain, an urban light rail link developed before the World Cup, connecting several neighbourhoods of Johannesburg with the international airport and Pretoria. According to a study by Lightstone Risk Management, “Since the plans for Gautrain became more certain, with 2005 figures seeing the most significant rise, price inflation of these Gautrain station properties have taken off, and have remained higher than the provincial price inflation ever since.” According to the report, in 2007, the median price of properties was R849,000 ($103,918) in neighbourhoods within 2 km of a Gautrain station and R760,000 ($93,024) within 2-3 km, compared to R625,000 ($76,500) for the Johannesburg market as a whole.

This infrastructure expansion has also driven property development. Nodes along the rail route, from the wealthier suburbs to commuter centres and on to townships, have witnessed a slate of urban redevelopment and mixed-use projects. However, there are significant challenges to the realisation of an urban renaissance based on an emerging class of consumers. In the residential segment, obtaining credit has become an increasing problem, particularly in the past two years.

For much of the past decade, the strong growth of the middle class has been supported by a tax and credit regime conducive to property ownership for these emerging consumers. In 2001 tax regulations were amended to allow an exemption on capital gains tax on primary residences of up to R1m ($122,400). In 2006, this was increased to R1.5m ($183,600). Such moves, which lubricated the residential sector, were supported by efforts to increase credit to the low-income market. Under the 2003 Financial Sector Charter, financial institutions committed R42bn ($5.14bn) in housing finance for the low-income market.

MORTGAGES: The mortgage market has experienced robust growth over the past 10 years. Between 2003 and 2007, the total value of mortgages extended to the domestic private sector grew from R332bn ($40.6bn) to R853bn ($104.4m), according to the Global Property Guide. However, despite favourable conditions for mortgage growth, including historically low interest rates, credit for housing has slowed considerably over the past two years. In the first half of 2011 the value of mortgage balances in the household sector was up a mere 3% on the same period of 2010, according to Absa Home Loans. This figure came at a time when the cost of servicing mortgage debt was decreasing, which, as a percentage of disposable income, stood at 4.1% in the first quarter of 2011, down from 4.3% in the previous quarter, the lowest ratio since 2006. Much of this is attributable to low interest rates, with banks’ prime and variable mortgage rates standing at 9% in the first half of 2011, the lowest lending rates since the beginning of 1974, according to Absa. Consequently, monthly mortgage repayments were 33.5% lower in the first half of 2011 than in December 2008, before the full effects of the global economic crisis were truly felt.

AFFORDABLE HOUSING: The cost of getting on the housing ladder is becoming less of a barrier. However, it is still significant. According to Absa, in the second quarter of 2011, monthly repayments at a mortgage rate of 9% for an emerging consumer (LRM 6 on the SAARF Index) looking to buy an affordable house – one with an average nominal price of R312,360 ($38,234) – with a loan-to-value ratio above 90% and a term of 20 years, would come to 44% of average monthly household income. In 2008 consumers in LSM brackets 7 to 9 (R9644-18223, or $1180-2230, per month) accounted for 44% of all credit extended to households, according to National Credit Regulator figures. Therefore, even with historically low mortgage rates, many consumers are still priced out of home ownership.

However, Ogbu believes the disparity between income levels and average mortgage repayments is less of an issue now. “This was a problem 10 years ago. We thought we had a racial and social issue, an income issue and sustainability-of-income issue. It’s always going to be difficult to take that first step [onto the property ladder], but the key is secure employment,” he said. “Housing prices have risen, but as multiples of income, they have not increased as much as the UK, for example.”

There is certainly a market for affordable housing and equally an appetite among developers to provide such units. This can be done on a commercial basis, but government support would be beneficial – perhaps in the form of loans with below-market interest rates.

Affordability is not the only issue. For all segments of the market, and the middle-income segment in particular, stunted mortgage growth is resulting less from the cost of borrowing and more from heavy indebtedness and poor credit records. According to Absa, the household debt-to-income ratio was 75% in the third quarter of 2011, slightly down from the 76.8% in the first quarter. The ratio of mortgage debt to disposable income stood at 44% in the third quarter of 2011. Furthermore, some 46.2% of credit active consumers (8.83m individuals) had an impaired credit record in the third quarter of 2011, according to the National Credit Regulator. This has in itself created a barrier to mortgage uptake and impaired banks’ ability to lend.

CREDIT ACT: The South African government tried to address this level of indebtedness through the National Credit Act (NCA) that came into force in June 2007. Under the terms of the act, lenders have to assess the ability of borrowers to pay, mandating that attachable income is sufficient to pay back all loans that an individual has within 36 months. The act also mandates interest rate caps on seven different types of credit, including mortgage agreements. A report by the regulator published in 2009 that assessed the impact of the NCA one year after its introduction argued that the act has had both positive and negative effects in terms of access to credit. It concluded, however, that, “Since June 2007, some providers had experienced a lower rate of new account acquisition. This was attributed to the higher rejection rate, the more rigorous application process and providers’ own risk aversion in this particular phase of the economic cycle.”

Banks, including Absa, have suggested that this has become a pronounced trend, with the NCA putting the brakes on the sharp mortgage growth that was present until 2007. As such, there remain certain impediments to the growth of the residential sales market. This has been reflected in residential house price trends for 2011. The impact of credit impairment, coupled with rising inflation and a persistent unemployment problem, has blunted demand and led to a softening in house prices across the board.

HOUSING PRICES: According to Absa Home Loans, the affordable housing segment saw a nominal price increase of 2.4% and a real price decline of 2.5% in 2011, while the middle-income housing segment witnessed a nominal increase of 2.2% and a real price decline of 2.7%. At the luxury end of the market, real prices declined by 3% in 2011. This follows moderate to minimal growth across all sectors in 2010. This house price malaise was evident throughout the country, with few markets showing much promise. According to Absa Home Loans, only Free State (1.3%) and Mpumalanga (0.7%) out of the nine provinces showed real growth in 2011. The worst-performing area was Eastern Cape, where house prices fell by 6.2% in real terms. South Africa’s two major cities fared little better, with prices in Greater Johannesburg falling by 0.5% in real terms and declining by 5.8% in Cape Town.

The poor performance of the Western Cape and the Mother City suggests the holiday and second-home market may be under significant price pressure. Given the ramifications of the global crisis, buyer sentiment in established customer markets, such as the UK, is likely to have been damaged. However, while there are no restrictions on foreign ownership, local brokers suggest the influence of foreign buyers on the second-home market is often exaggerated. Mike Greef, the CEO of Greef Properties, an affiliate of Christie’s International Real Estate, told the New York Times in July 2011 that foreigner buyers make up less than 5% of the market in Cape Town, although this is above the national rate.

It is clear that the luxury segment, for which the Cape peninsula is known, is suffering, although as Malcolm Horne, the CEO of Broll, a local CBRE affiliate, points out, prices for high-end property remain quite competitive both regionally and globally. “While property is perceived as expensive by locals, it is a relative bargain compared to what one pays for similar quality elsewhere in the world and is substantially cheaper than what you would pay for scarcely available top-grade property in sub-Saharan Africa,” he told OBG.

In the meantime, however, the driving force of the market is likely to remain in the affordable and middle-income areas. The lower segment’s current underper-formance is a concern, but not everybody believes that this should dent the aspirations of South Africa’s emerging consumers, nor deter investors from looking at the real estate market. The rental market, in particular, is relatively undeveloped in South Africa.

RENTALS: However, from the investor perspective, there seems little interest in the buy-to-let market. According to a First National Bank (FNB) survey for the third quarter of 2011, the buy-to-let market made up only 8% of the total home-buying market, a precipitous fall from above 25% in 2004. FNB suggests that most investors look at the property market for capital growth prospects. Despite a slowdown in growth, rental rates are continuing to climb, thus indicating that there are opportunities for discerning investors. According to the Statistics South Africa “Home Rental Survey” for September 2011, rental rates grew at 4.7% y-o-y, down from 5.9% in the second quarter. The most robust rise was in townhouses, with rate increases of 5.4%, followed by flats (5.2%) and houses (4.2%).

An August 2011 report by Global Property Guide suggests that investors can achieve rental yields above 8% in Cape Town and over 10% in Johannesburg, significantly above the benchmark interest rate of 5.5% in 2011. Nonetheless, there seems to be little investor appetite for this market. FNB suggests that financial pressure on tenants could be deterring potential owners from leasing properties. Data from the Tenant Profile Network shows that the percentage of tenants in “good standing” declined from some 82% in mid-2010 to 79% in the second quarter of 2011.

OUTLOOK: The conditions, therefore, remain difficult for investors. In the residential market, both capital growth and rental yield growth are currently muted. The industry has been hit by a lack of demand stemming from weakened consumer confidence, rising inflation and obstacles to credit growth. Nonetheless, many of these challenges are tied to the slowdown in the economy, a situation that may well begin to ease over the coming 12 months. Indeed, the longer-term trends suggest a brighter future for the industry. South Africa’s young, and increasingly wealthy, population should offer many opportunities for investors and developers in all facets of the real estate sector in the next decade.