Buy-to-let has become buy-to-regret

It seemed like such a good investment idea, a no-brainer really. You bought a rental property with a small deposit, a large mortgage and got someone to rent it, paying off your mortgage bond to the bank. Ever-rising rentals ensured you would start generating some extra-cash in the near term.

Then ten, 15 or even 20 years later, when the bond was paid off, you either collected the rent sans mortgage to live on or you sold the units for a fat profit.

How things have changed

While buy-to-let (BTL) was a fringe investment for property-savvy investors for a long time, myself included, it became mainstream during the last residential property boom which lasted roughly from about 2002 to 2008, by which time the global financial crisis hit with gale force winds, coincidentally also as a result of financial shenanigans in the property financing arena in the biggest property market in the world: the US.

Such was the allure of BTL that at the peak of the market in 2008, almost 25% of all residential property sales in SA were in the BTL category, according to FNB.

This has now dwindled to below 6%, as commercial banks have become extremely circumspect in granting bonds for BTL purposes, and will only grant them to blue chip clients with impeccable balance sheets and only in certain areas. Expect this statistic to lower even more in months ahead.

In the boom times property developers, mortgage banks and estate agents created such a compelling argument that it was considered to be foolish and short-sighted not to partake in this credit-induced property gluttony.

A perfect storm has now hit the BTL market and literally tens of thousands of BTL investors countrywide, perhaps with the exception of the Western Cape are, according to one BTL-owner “slowly being squeezed to death by a giant financial anaconda”. Rates and taxes have been rising on average at almost double the inflation rate per annum over the last five years and more.

And, as properties get older, maintenance costs rise while property values themselves, both in real terms and in some cases in nominal terms, decline.

Since 2008 the residential property market has declined by about 20% in real terms and is still firmly in a bear market. The outlook for the residential property market on the whole is decidedly negative.

Lipstick on a pig

Yet property marketers are desperately trying to put lipstick on this pig.

Reading my Sunday property supplement over the weekend I found two pieces of marketing bumpf.

The first one quoted Adrian Goslett, regional director and CEO of RE/MAX of Southern Africa in the Sunday Times as saying: “Property is far less volatile than the equity or share markets. Property prices tend to increase consistently over time which makes it a lot easier to gauge the estimated return on investment. Property owners will not have to sleep with one eye glued to the stock market and have to sell the minute the market is at a high.”

Why do I disagree? Volatility in equity markets in itself is not a risk-factor: every seasoned investor will know that. It’s simply a function of the liquid and transparent global markets that are measured on a second to second basis.

In contrast to residential property prices, equity markets are measured and analysed on a continuous basis and investors can work out their net returns on a daily basis. Residential property prices by comparison are almost impossible to gauge. Take this piece of advice with a very large dose of salt.

Elsewhere in the same publication Jan Davel, MD of the RealNet estate agency advises: “The tight conditions at the moment represent some good opportunities for investors with a medium- to long-term outlook. All indications are that there will be a resumption of stronger value growth in the market within the next two to three years.” Where that growth will come from – considering the prospect of a ratings downgrade in the near future – remains to be seen.

To his credit Davel, elsewhere in the article, does offer a more realistic assessment of the true state of affairs when he says: “…although rental properties are currently in high demand, actual rentals are unlikely to rise much over the next two to three years”.

I have written extensively about the lacklustre performance of the SA residential property market. Every time I do my inbox is filled with emotionally-laden emails from property-pundits trying to offer a different view, sometimes with some unprintable expletives thrown in just to make a point.

Trust me: I am the first to want to be writing something rah-rah about the property market. I was the original residential property market bull many years ago, but like Dr Tim Noakes of Banting-diet fame, I’ve also had my Damascene conversion along the way and have had to change my way of thinking.

Why? Simply because the facts have changed and, as such, the advice has to change. Until the facts themselves show otherwise I have to warn again that BTL, under current economic and political conditions in SA, could prove to be very costly to your personal wealth. There are better, cheaper and smarter ways to make money from property investments.

The Rental Monitor (Q4 2015) report, on credit bureau Tenant Profile Network’s website makes for sobering reading for existing or potential BTL investors.

The report focuses on one key determination of the BTL equation: the tenant. How much is he/she paying, is this amount rising every year and is your tenant paying on time?

Herewith a few aspects regarding timing of payments:

  • 69% of renters pay their rent on time
  • Of the remaining 31%, 11% paid late
  • 5% were given a grace period
  • 5% did not pay

This alone should make you think twice about considering a BTL as an investment. You have over 30% chance of your rent being late or not being paid.

Meanwhile you are responsible for rates and taxes, the bond repayment, the insurance and all other costs.

Tenants have more rights than you

As an owner you have far fewer rights than a delinquent payer. The legal process of getting a non-payer out of your property, of which there is a high chance during your lifetime, takes about four months and between R20 000 to R30 000. So your eventual loss equates to the loss in rent, legal costs and probably repair costs to your property. Someone who you have to evict from your property will not look after it. It’s more likely you’ll end up with a trashed property.

As an aside, I understand that there is legislation in the pipeline that, if enacted by Parliament, could mean a substantial fine and/or imprisonment for the owner of a residential property if the correct procedure is not followed in evicting a non-paying tenant.

The chapter in [the Rental Monitor report] on average rent and escalation gets to the heart of the current problem with regards to BTL. Quite simply, with the exception of the Western Cape (gosh, this is getting annoying for us living in Gauteng) and to a lesser extent in the Northern Cape, rental growth has been slowing for almost three years and in some parts of the country has gone hugely negative.

Let’s first look at the national average for rental escalations. In the Q4 2013 rentals were galloping ever-higher at a rate of 9.29%, far in excess of the inflation rate. But since then escalation growth has fallen off a cliff and during 2015 was substantially less than the inflation rate and the latest number was 3.21% in Q4 2015.

If one strips out the effect of the escalation rate in the Western Cape (it’s remained consistently above the inflation rate and was at 9.96% in Q4 2015) then the national average in rental growth is closer to zero.

Rental growth in 2015 in Mpumalanga was below zero while actual rentals in Limpopo at the end of 2015 were 16% lower than two years ago. Average rentals in North West are about the same as they were in 2012.

These statistics prove without any doubt what I personally have been experiencing and what an ever-growing number of BTL investors are finding out for themselves.

Apart from the Western Cape, property prices and property rentals are not rising but costs and the hassle factors are.

I would suggest that the BTL market, unless the current trend doesn’t reverse, could soon find itself in a negative equity situation. Negative equity refers to the realisable value of the property being less than the outstanding bond.

Almost weekly I see the sales in execution of properties deeply in negative equity, either at Langebaan and Shelley Beach in the Cape or Hartbeespoort Dam in North West Province, for example.

A recovery in the BTL, as Davel admits, is far off into the future. A few things need to happen before there is any realistic chance of current BTL owners seeing their fortunes improve. This includes economic growth and rising employment in the formal sector, rising  consumer confidence as well as an improvement in individuals’ financial situation. It will also assist greatly if rates, taxes and bond mortgage costs come down but on both accounts prospects are slim.

How BTL owners, some of them with their retirement packages in a portfolio of units, would love the immediate liquidity of a listed property share, which trades daily.

Listed property investments, by the way, have been the best investment class over the last ten years, returning almost 20% per annum year after year. The difference in net wealth between a BTL investor and JSE-listed property investor or, even better, a global fund, over the same period must be enormous today.

But they can’t get out in a hurry; they are literally bogged down in the quicksand of an illiquid investment which is putting huge pressure on personal cash flows with no easy way out. The only way to raise some cash in a hurry is to sell it at a reduced price, probably using the same estate agent who recommended it as a good investment some ten years ago, and then paying a commission of anything up to 7% to do so.

Oi vey, as they say.

Article from Moneyweb, Magnus Heystek | 5 May 2016 00:01.