Rocket science or common sense?

Rocket science or common sense?

For Sale Sign

One of the things that I just cant get my head around is the price of residential property. If the experts are to be believed, then the average house price in SA is somewhere around R550000. In order to buy this property, you would need to put down a deposit of at least R110000 (20%) and would then have to pay off a bond of R440000. With the prime rate at 11% and assuming you could get 0.5% below prime (not nearly as easy as it used to be) then this would leave you with a monthly repayment of just under R4400 (R4393). In order to qualify for this bond you would need to have a combined monthly household income of ±R14500 per month.

Here in lies the problem: the average salary in South Africa does not even come close to this amount. According to Finscope 2008, the average household monthly income in SA is ±R5750 (R10000pm in Joburg and ±R6400 in CT). So how do Mr and Mrs Average buy the average house? They cant!

So who is buying all the houses and why would they do this?

Conventional wisdom states that you cant go wrong with buying residential property as an investment. Currently a R500000 house might realise a rental income of ±R3000 per month (before commission, rates etc). If we assume a net income of R2500 after expenses then this equates to a rental yield of ±6% per annum. This is not a great yield and seems to decline even more as the value of the property increases. In fact, rental yields have not been good for quite a long time now.

If I took my R500000 and put it in the money market, I would get a yield of ±8% at this stage so the rental yield is not that attractive (in both cases these are pre-tax yields).

So why would I buy the property?

Capital growth of course! After all, property only goes up over time! Apparently this is not a given and as property prices have fallen over the past 2 years not only have people seen their values decline but many people are also sitting with negative equity on their properties (i.e. they owe more on the property than it is worth and in many cases the rental income does not even come close to the bond repayment).

Now my problem is this: if Mr and Mrs Average cant afford the average house (because they don’t earn enough) and as a result they need to rent, how are they going to be able to afford increased rentals either? As I see it, they cant afford to buy their own place (prices are too high) but neither can they afford to subsidise someone else’s retirement plan and desire for rental yield and so either rental yields will have to stay low (and you should rather use the money market for income) or else property prices have to fall (and you should stay far away from this).  Why take good money and stick it into an investment property with a poor yield and little prospect for growth?

If you are seriously thinking about buying a property to rent it out then my advice would be to be patient, something’s got to give.

That’s all for now!

The Financial Coach™