Average rentals flat, but not for Northern Cape
The average residential rental in South Africa has remained above the R6,500 level in the third quarter, currently at R6,508, but has shown no movement since the previous quarter (ending in June 2015). This is according to data from PayProp.
“Long-term, year-on-year growth in rentals has been rallying since January 2015, after a prolonged down-turn,” it says. “And based on previous growth cycles we’ve been expecting the upturn to last until the end of the year at least, and growth rates to pick up from 5.04% in January to around 10%.
“However, as a result of the cessation in growth, this quarter effectively marks the beginning of a downward dip in year-on-year growth. Average growth dropped from 7.56% in June to 7.28% in July, and ended on 5.18% in September.”
A provincial winner
The Northern Cape is now officially the most expensive province in which to rent in the country, with average rentals topping out at R7,219 per month this quarter. It overtook Gauteng, which had led for two consecutive quarters. The Northern Cape has seen more than 12 months of back-to-back double-digit growth rates.
No recovery in sight for Limpopo and Mpumalanga
Mpumalanga and Limpopo, historically the top-performing provinces, have of late been languishing behind new frontrunners Northern Cape and Gauteng. Rentals in Mpumalanga continue to decline on a year-on-year basis, with the latest figures showing a 2.2% drop, while Limpopo has recorded positive growth for the first time this year. Unfortunately, Limpopo’s 2.6% has hardly been enough to drive a solid recovery in average rental values, according to PayProp.
Stability in the anchor provinces
The economic powerhouses of KwaZulu-Natal, Western Cape and Gauteng maintained their stable growth at 8.2%, 9.5% and 8.6%, respectively. If the three largest provinces continue to post growth that outstrips inflation, it may soften the severity of the decline in average growth rates PayProp projects.
Underlying pricing dynamic
“Over time our quarterly report on residential letting trends in South Africa has pinpointed a migration of rentals from the lower-priced bands to the higher-priced ones,” says PayProp. “But while the graph below highlights impressive growth in the >R10,000 categories, it is important to keep in mind that 77.4% of all rentals are still below R7,500.”
Continued growth in >R15,000 rentals
Interesting dynamics come to the fore when considering growth in rentals above R15,000. While the graph below shows a decline in that band, it is still an impressive number (from 72% at its highest down to the current quarterly average of 47%).
“We often look to rentals in this price category as the ‘canaries in the mineshaft’ when projecting provincial growth rates,” says PayProp. “According to the hypothesis we’ve developed over the years, a drop in this price category is a first indication of a possible downward cycle in a particular area. If we look at the movement in this category in Limpopo, for example, we see that the current downward trend in average rental values began with a reduction in the growth levels in high-end rentals.”
While the Northern Cape is the largest and currently still the fastest-growing province in terms of monthly rental values, PayProp is concerned about the sustainability of this growth. “The first red flag we must heed is the slowing down of the phenomenal year-on-year growth levels we’ve been seeing in this province,” the company says. “Currently, at a quartered average of 10.8%, this figure is at its lowest in 18 months. Over the three months making up Q3, growth fell from 10.9% in July to 10.5% in August, ending at 7.7.% in September. If this trajectory continues, the Northern Cape may not be in the top spot for very much longer.
“Additionally, the growth in rentals above R15,000 has cooled down dramatically in this province from its heyday levels of 223% (Q3 2014). It was determined then that the runaway growth was probably the result of bulk corporate rentals being signed on the back of industrial development. We would hazard a prediction, based on the figures we are currently seeing, that the expansion boom is over and may even be contracting, possibly affected by the economic shifts in mining towns affected by softer global commodity prices.”
Damage deposit ratios down some more
The damage deposit ratio (how big damage deposits are in relation to rentals in a given area) continues to make for interesting analysis.
This ratio peaked at 1.42 in Q4 2014 (where the average damage deposit is 1.42 times the average rental value), but has since gradually dropped to 1.38. While the difference may seem marginal, it has had a massive overall effect. In PayProp’s sample set, for example, it means that R10m less is being held in deposit for the same value of rentals a year ago. When applied to the estimated 1,5 million rental properties in South Africa, R200m less is being held in deposit to secure a rental pool of the same value.
For the first time in more than two years, net yields have dropped below the 5% level (currently at 4.94%). The drop has been driven by quarter-on-quarter rental growth of only 6.7%, versus average property value growth (calculated on the same basis) of 7%. Combined with rising costs of ownership, this has held investors back from entering the market.
“We have experienced a subtle shift in the market as a result of this change in the return model,” says PayProp. “Larger institutional investors are entering the market as bulk investments generally result in lower capital costs and a lower per unit management and maintenance costs due to economies of scale.”
On a provincial scale, Limpopo still offers excellent returns (7.52%) despite the decline in real values – as it takes a while for the growth trend to close the gap to net yield levels. PayProp does however expect to see net yields in this province drop back from the number one spot by next quarter, as rental growth remains flat.
The Northern Cape comes in second at 7.16% – although this is a slight drop from the 7.64% achieved last quarter.
The Western Cape and Gauteng are struggling at the lower end of the yield range. This is not, as may be expected, because of low rental values in these areas (which is the reason for the low yields in the Eastern Cape), but because much higher property values make it harder for a buyer to enter the buy-to-let market, raising the barrier to achieving profitability. In these circumstances, rentals need to consistently outpace property value growth to ensure positive growth in returns for investors in these areas.
“Our tenant analysis is based on data abstracted from tenancy applications – specifically PayProp Capital’s Tenant Assessment Report (TAR),” says PayProp. “Providing a unique view on tenant risk, the TAR has grown from strength to strength in the market, and in the latest sample batch we were able to include roughly 15,000 tenant records.
“This data gives us a unique data set on which to frame an understanding of the financial health of the average South African who uses an estate agent to source a rental. However, this report has only been available to PayProp customers for the last 12 months. During this time it has attained coverage in all provinces, but we do not yet regard all provinces’ data as reliable indicators of actual rental trends, and thus exclude some provinces from our data set.
“From the available data we draw our first important insight concerning the relation between tenant income and debt repayments. Over the past three quarters a concerning trend has been emerging that shows tenant incomes declining while their debt repayment commitments are increasing. As a result, tenants are currently spending close to 37% of their income on repaying debt, as opposed to 32% at the beginning of this year (otherwise known as the debt repayment ratio).
“Provincially, the data provides an even more interesting perspective. Limpopo, where we have seen a decline in average rental increases, shows a corresponding increase in debt repayments relative to income. The same trends are at work in Mpumalanga. Given that the percentage of high- to very high-risk tenants in this province has increased from 47% to 63%, the data suggests that there is significant economic pressure on tenants in this area.”
In Gauteng, the debt repayment percentage is of particular concern, as the percentage of high-risk tenants has likewise increased, from 41% to 44%. The Western Cape debt-to-income ratio has been fairly stable, and in lock-step with the increased percentage of high-risk tenants in this province – from 36% to 32% over the past three quarters. KZN shows a similar trend, with a stable debt repayment ratio and a high-risk percentage holding steady at 41% over the three quarters.
When examining the debt repayment ratio in terms of its component parts – debt and income – Western Cape tenants report the highest average income. The Free State is of concern here, as it has the highest debt repayment commitment but only the third-highest reported income.
The high debt repayment levels are driven by the number of accounts held by prospective tenants. On average, a prospective tenant holds 7.5 CPA accounts (Credit Providers Association accounts, that consists largely of asset finance, retail credit and contractual service providers) and 3 NLR accounts (National Loan Register accounts, which typically involve the provision of cash on credit).
“The number of accounts has stayed fairly stable over the year and it would be interesting to see if this figure increases over the festive season,” says PayProp. “A tenant’s credit behaviour is reflected through their credit score. Most credit bureaus use a numeric scoring system that rates a tenant’s creditworthiness on a range between 500 (bad) and 700 (excellent). The average tenant scored 596 for this quarter, which is marginally down from 601 the previous quarter.”
The average tenant
What does all this mean for the average tenant? If we combine debt repayment with all of a tenant’s other obligations in a cash-flow analysis, it is of concern to see how little is left for living expenses (once taxes, rental and debt repayments are deducted).
Interesting times ahead
Unfortunately, there is precious little positive news about this quarter and more significantly, the forecast for the near future. “First, we are concerned about the slowing growth rate in rentals, which, coupled with a drop in the damage deposit ratio, makes it clear that tenants are under pressure,” says PayProp. “When looking at the actual financial data of tenants, our concerns are supported by the increasing level of indebtedness – a leading indicator of a drop in average credit scores.
“Provincially, North West Province, Northern Cape, Limpopo and Mpumalanga ought to provide interesting test cases to see how these dynamics will play out in areas where the underlying resource-based economy is increasingly under pressure.
“Our advice to agents and landlords remains to ensure adequate tenant risk assessments are done, to ensure tenants are able to afford the rentals that they apply for and to consider additional processes and products, including our DepositGuarantee, to cover your landlord’s and business’ risk.”