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Why buy-to-let properties could become more enticing

Cape Town - There are indications that rental inflation could noticeably be outpacing weak house price inflation, making buy-to-let properties an attractive buying opportunity, according to John Loos, household and property sector strategist at FNB.

In the third quarter of 2016, the revised FNB-TPN National Average Gross Residential Yield declined very slightly from the previous quarter’s average, after having risen in the second quarter.

"While we didn’t see a further rise in the average gross yield on residential properties in the third quarter of 2016, the fourth quarter house price growth slowdown suggests that house price growth in that quarter began to noticeably underperform various estimates for rentals. This could be pointing to rental inflation perhaps nearer to 5%," Loos said on Tuesday.

READ: 10 tips for managing buy-to-let properties

"TPN’s estimates of annual rental escalations, having previously gone through a slowing period from 2014 to 2015, have more recently shown some mild strengthening in 2016. From a low of 2.8% year-on-year (y/y) as at the final quarter of 2015, the average rental escalation had shown some moderate increase to 4.25% by the third quarter of 2016."

In 2017 Loos expects average house price inflation to by and large underperform rental inflation, as another tough economic year is anticipated. He projects house price growth for 2017 to average around 3%, down from 5% in 2016. This will be in lagged response to the economic growth slowdown and interest rate hikes of recent years up to 2016.

"The result is expected to be some gradual increase in the average gross yield for 2017 - 'gradual' being the operative word - from an expected average of around 9.1% at the end of 2016 to nearer to 9.3% by the end of 2017," said Loos.

Average gross yield

The national average gross yield declined slightly to 9.06% in the third quarter of 2016, from a revised second-quarter level of 9.11%. This comes after the second-quarter average rose from 9.07% in the first quarter.

The average gross yield had previously declined from a high of 9.22% back in the final quarter of 2013 to 9.07% by early 2016, driven lower by a period of solid home buying performance up until not too long ago, which resulted in solid house price inflation until the early stages of 2016.

"After that second-quarter increase in the average yield, we had believed that it could be the beginning of a longer gradual rising trend in yields, given that many of the fundamentals pointed towards it. Interest rates had risen gradually from early-2014 to early-2016, and a multi-year economic growth slowdown since around 2012 had exerted downward pressure on home buying demand," explained Loos.

By 2016, this had begun to exert some downward pressure on house price growth and slower house price inflation that underperforms rental inflation is exactly what is needed, in his view, to lift yields and make buy-to-let a more attractive buying opportunity.

"But our expectations of rising yields proved to be a little premature, the third quarter of 2016 data suggests. Nevertheless, we don’t believe that the third quarter decline in the average yield is a cause to modify our expectations and remain of the expectation that 2017 will be a year in which yields could rise more noticeably," concluded Loos.

"Our reasoning is in part due to the fact that, according to the FNB House Price Index in the 4th quarter of 2016, we began to see average house price growth slow more noticeably."

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