Property research articles

It appears estate agents and house investors and other stakeholders in the housing market have experienced serious anguish and denial following the launch of Rode’s Report (quarter 4 of 2011) on 26 January 2012. At the press conference I stated that houses were fundamentally overvalued by at least 25%; furthermore, that house prices will, as a consequence, decline in real terms over many years (unless one assumes a quick collapse like in the USA).

Heritage practitioners and other concerned parties in Cape Town are up in arms. The war of words was prompted by the proposed addition of a parking garage and office block on top of a dilapidated warehouse built in the VOC era, situated in the so-called Lutheran Church block in the Cape Town CBD. Since heritage has economic (tourism) value, we should all be concerned when we destroy our heritage, whether through wilful neglect or otherwise.

An onerous title deed condition that isn’t discovered in time could delay or prevent the progress of a property development – with serious cost implications. Alternatively, such an omission could be costly when buying or selling property.

The two crucial determinants of income-producing properties’ market value are market rentals and capitalization (cap) rates. By comparison, all the other determinants are incidental.

In the residential property market, estate agents and valuers have a serious problem in estimating the market value of a house. The reason for this is the phenomenon of galloping prices that invariably means that the historic comparable sales on which an estimate of market value is based, are outdated the moment they become available to market players.

The below-par investment performance of most South African retirement funds over the past few years was recently again put under the media spotlight. Yet, some asset classes have done exceedingly well over this period. This begs the question whether fund managers have been prudently weighing up the weights of the various asset classes in their portfolio mixes, and whether these managers should have read the signs of the times better — not with hindsight but foresight.

Hurdle rates required by investors to induce them to invest in property were basically un-changed at 19% in quarter 2003:1 — a level at which they have been for many years. At the same time, the leaseback escalation rate got stuck at 10% or higher. This is in spite of the dis-inflationary environment in SA, the generally favourable prognosis for long-run inflation and the long-term character of property investments.

Ever since the fourth quarter of 1991, Rode’s Report (RR) has been publishing regression equations to calculate the capitalization (cap) rate of office-building and industrial-building properties. These equations are based on the premise that the gross market rental com-manded by a property, is a crucial determinant of its cap rate.

In an inflation environment, the purpose of contractual rental escalation rates is to obviate the need to renegotiate the contractual rental once a year or so. In a hyper-inflation environment, this “or so” could be monthly, of course. Instead, the periodic in-lease rental escalation is an attempt by the parties to the lease to forecast the growth path of market rentals over the duration of the lease. Hence the market escalation rate on rentals is at any one time nothing but a forecast by the market of the probable growth rate of market rentals over the duration of the lease.

It is hard to believe that 15 years ago, the market rated listed property far superior to long bonds, a situation that has since been totally reversed. The question is why?