Are buy-to-let investors acting irrationally?
06-04-2005
The hot housing markets in several countries worldwide are showing signs of cooling off for the first time since 2002, according to The Economist’s global house-price indices.
Australia showed the most dramatic deceleration with the 12-month increase in house prices during 2004 down to only 2,7% compared to 18,9% the previous year. Price increases in New Zealand came down sharply as well, from 24,8% by the end of 2003 to 13,5% at the close of 2004. Slowdowns were also evident in the UK, Ireland, Canada, Switzerland, Italy and the Netherlands, while prices in Germany and Japan continued to decline.
Housing prices in the USA were up by 11,2% over the year, and although the overall rate of increase slowed in the fourth quarter, in areas like California and Washington DC, it rose by more than 20%. This has prompted Alan Greenspan, the Fed’s chairman, to admit to congress recently that he was concerned that there may be property bubbles in “certain areas” and a risk that prices could fall. The Economist reports that speculative demand seems to be playing an increasing role in fuelling prices as a new study by the National Association of Realtors shows that one quarter of all houses bought in 2004 were for investment, not owner-occupation.
According to ABSA’s house price index, South Africa still topped the charts in 2004, with house prices that grew at just over 32% — about 11% points more than the growth rate in 2003.
As in the USA, the hot house prices in South Africa ironically seem to be luring an increasing number of buy-to-let investors into the residential property market, in spite of the poor income returns currently offered by the housing segment, says Rode & Associates property economist Erwin Rode.
“With house prices so high, rentals relatively low, and most investors gearing themselves heavily when they buy, returns are unsustainably low,” warns Rode. “Something has got to give. Either rentals must rise considerably, or housing prices must dip.”
According to Rode, neither of these scenarios seems likely to unfold in the foreseeable future. With a steady demand for housing continuing in the current positive economic environment, housing prices are unlikely to give much and even 10% off the peak won’t be nearly enough. On the other hand, rentals can only rise sharply if demand for rental space were to outstrip supply. Considering the increasing number of buy-to-let investors in the market, and assuming a reasonably elastic supply of housing, there seems to be little prospect of such a disequilibrium evolving soon.
For South Africa’s current residential-property income yields of 5% to revert back to 10%, can take years, predicts Rode. He admits that there may be exceptions in certain market pockets.
The bottom line, says Rode, is that buy-to-let is not a wise investment decision at the moment. He equates it with the buying of a dotcom share during the dotcom bubble era of 2000.
“When one starts to hear investors saying that rental income doesn’t matter because of the current phenomenal capital growth of houses, it sounds very much like a repeat of the ‘irrational exuberance’ expressed by the dotcom investors in 2000. They said then that the link between share prices and profits no longer mattered – and we all know how many investors lost their money when that bubble burst.”
