Understanding the Buy-to-Let Market

Buying a property with the intention of letting it can provide you with a steady monthly income. Unless you’ve paid cash up front for the property; put down a sizeable deposit; or managed to buy the property below its market value (for example at an auction), it will likely be some time before you reap the cashflow rewards of owning a rental property. Buying-to-let is a long-term investment strategy, and it requires some serious thought and research before you start the search for your ideal investment property.

The state of the South African rental market

In South Africa, PayProp’s Annual Market Report 2018, showed that nationally, rental growth slowed to 4.14% in the last quarter of 2018, vs. 5.39% over the same period in 2017. It stated that this was the first quarterly uptick in the rental growth rate in two years, and also the highest quarterly year-on-year growth for 2018. Nationally, individual net income levels have stagnated, increasing by only 1.56% between Q4 2017 and Q4 2018. With rent and inflation increasing at higher rates, consumers are struggling to keep up. PayProp explained that this only partly explains the year-on-year increase in tenants’ debt-to-income ratios – in Q4 2017, tenants paid R13,756 on their monthly debt repayments vs. R15,031 in Q4 2018. The increase in debt-to-income ratios, in turn, affects affordability ratios. As consumers’ incomes have grown more slowly than rents, the slight increase in the rent-to-income ratio was to be expected.

The report revealed the average national rent to be R7,610, which moved it into a higher rental bracket in Q4, from the R5,000 – R7,500 category into the R7,500 – R10,000 category. It confirmed that the R5,000 – R7,500 bracket is still the most populous in South Africa, comprising about a third of all rentals, and there is no expectation of this changing soon.

Assessing rentals on a regional basis, PayProp’s report showed that the Eastern Cape has the lowest average household income of all the provinces but is the second cheapest province in which to rent. The province’s rental growth rate increased from 2.54% in Q4 2017 to 3.39% in the same quarter in 2018, but growth was still subdued in the province and below the national average of 4.14%.

In the Free State, rental growth increased significantly, from 2.35% year on year (YoY) in Q4 2017 to 8.25% in Q4 2018 – the highest growth percentage out of all the provinces. In Gauteng, the average rent breached R8,000 for the first time in Q4 2018. This was 4.84% more than the year before and the third highest growth rate in the country for the quarter. While this rate was lower than the year before, it was the province’s first increase in quarterly growth in two years.

KwaZulu-Natal (KZN) achieved the second highest rental growth for Q4 2018, at 7.25%. The province’s average rental in Q4 2018 was R8,129, and are the third highest average rentals in the country. Limpopo suffered negative year-on-year growth in all four quarters causing its average rent to slip from R7,472 in Q4 2017 to R7,173 in Q4 2018. This was the worst rental performance of the provincial markets.

Mpumalanga saw above average growth income-wise and rental growth of 4,74%. The average rental in Q4 2018 was R7,248 compared to R6,919 in the same period in 2017. The North West had the country’s lowest rents in Q4 2018, averaging R4,986 (R2,624 lower than the national average of R7,610), but because of the province’s high debt-to-income ratio, it also had the worst affordability ratio, at 89.9%.

The Northern Cape experienced slightly negative rental growth of 0.7% year-on-year, but still had the second highest average rents (R8,152), after the Western Cape — which yielded the lowest growth figures for the province since the launch of the Rental Index in 2012. Q4 2018 was the Western Cape’s lowest point of the year with growth slowing to just 3.9% – with December’s year-on-year growth barely moving at just 0.4%. That being said, the average Western Cape rent surpassed the R9,000 mark during the year reaching R9,124, still making it the most expensive province to live in with an average price differential of nearly R1,000 compared to the second most expensive province.

When it comes to purchasing the property you intend to let out, understanding the projected forecasts across the value bands is important too.

Lightstone Property’s forecast reveals the Luxury Market segment (R1.5 – R3 million), as having had a disappointing performance in 2018, and this trend of negative nominal growth is expected to continue in Q1 2019, before correcting during the second half of the year. The High Value segment (R1 – R1.5 million), saw price growth of 2.6% in 2018 and is projected to improve slightly during 2019 to end the year at 2.9%. Growth in 2018 was strongest in the Mid-Value segment (500k – 700k), which is projected to stabilise and end 2019 at 4.7%.

Paul Stevens, CEO of Just Property said in a January 2019 article on Property24, “The country’s rapidly increasing cost of living, predominantly a result of the increasing cost of fuel, has put severe pressure on consumer spending. Inflation is expected to be higher in 2019, and the possibility of interest rates increasing looms large. Both homeowners and tenants are going to be increasingly stretched to meet their monthly home loan or rental commitments.”

Stevens said they saw high vacancies and low rental escalations across the country, fuelled by lower than normal demand in 2018 and expect the trend to continue into 2019. “Historically, we have seen rental demand increase during tough economic times, but this is not happening now. Our data partners, TPN, report that average tenancy periods have increased to 18 months and the average age of tenants is now 32, up from 24 in 2008. Their data shows that fewer people are entering the rental market, and the majority of those that are, rent for less than R7,000 per month. The short- to medium-term opportunities for property investors and landlords therefore lies in properties that allow for multi-generational living and in properties that can be rented for R3,500 to R7,000 per month.”

Stevens went on to say that there is an increase in delinquency rates of tenants and a decrease in rental recovery rates, and advised that landlords should be more diligent in screening and managing their tenants.

The state of the US rental market

The Joint Center for Housing Studies of Harvard University’s biennial “America’s Rental Housing 2017” report, gives a good overview of the US rental market. It reveals that renter households are increasingly likely to have higher incomes, be older, and have children, and explains that the market has responded to this shift in demand with an expanded supply of high-end apartments and single-family homes, but with little new housing affordable to low- and moderate-income renters. This trend has resulted in nearly half the country’s renter households being cost burdened, and has led to an increased need for affordable housing, and the fostering of private development of moderately priced housing. The indication is that these trends are still valid and that the country is facing an affordable housing crisis.

According to Joint Center projections, even as the homeownership rate stabilizes, renters are still likely to account for slightly more than a third of household growth. The number of renter households is projected to increase by nearly 500,000 annually over the ten years from 2015 to 2025.

The report states that renting now appears to have greater appeal for households that could afford to buy homes if they desired. In 2006, 12 percent of households earning $100,000 or more were renters. In 2016, that share exceeded 18 percent, a cumulative increase of 2.9 million renters in this top income category. Indeed, these high-income households drove nearly 30 percent of the growth in renters over the decade. Even so, renting remains the primary housing option for those with the least means. A majority (53 percent) of households earning less than $35,000 rent their housing, including over 60 percent of households earning less than $15,000.

In addition, renters are now much older on average than a decade ago, reflecting both an increase in middle-aged households that rent and the overall aging of the population. The median age of renters thus increased from 38 in 2006 to 40 in 2016. Although roughly a third of renters are under age 35, nearly as many are now age 50 and over. With renting more common across age and income groups, renter households are more representative of the broad cross-section of US families. Most notably, families with children now make up a larger share of households that rent (33 percent) than own (30 percent). Married couples without children, in contrast, make up 37 percent of homeowners and just 12 percent of renter households. Single persons are still the most common renter household type, accounting for fully 37 percent of all renter households.

In terms of buy-to-let investments, there are signs that rental markets are at a turning point. Real rents are still climbing, but at a slower pace now that vacancy rates are ticking up. Returns for rental property investors remain healthy, but the influx of high-end supply has begun to dampen financial performance in many prime urban locations. There continues to be a vast undersupply within the low-cost segment, and investors might be well-served by focusing on this market segment.

Closing thoughts

There is clearly currently cause for concern from a landlord’s perspective in South Africa. While some property investors are seeing respectable returns on their investments, many appear to suffering the consequences of a muted economy, and the resulting tenant delinquency. There are short- to medium-term opportunities for property investors and landlords in properties that allow for multi-generational living and in properties that can be rented for R3 500 to R7 000 per month. However, local investors may be better served by looking into potential offshore property investments, such as those available in locations with high growth potential like Atlanta, Georgia in the United States. Success could be achieved offshore, by focusing on property investments that answer to the high demand for rental properties that address the needs of families in the low to middle income segment.

Correctly managed investments — from the purchase of the right property, to close management of necessary renovations, and securing the right letting agent who will perform careful due diligence on potential tenants — do have scope for a potential healthy return on your local and international property investments.