Chapter 1: What is invest-able residential property?
This is the first of a six-part series about residential rental property as an asset class in the South African context.
As residential property becomes a more prominent feature of the investment landscape, asset managers are grappling with questions as to how this asset class performs relative to other property types. They want to ascertain if residential property is a long-term worthwhile investment. They want to understand the outlook for the market, analyse its strengths and weaknesses and confirm if residential property is a viable asset class compared with other real estate investments. They want to know if rental housing assets deliver income consistently and reliably.
This series aims to answer these questions through analysis and targeted interviews with seasoned industry professionals.
The Residential Rental Insights series is sponsored by Divercity Urban Property Group.
Understanding the residential asset class
During Apartheid, South Africa (SA)’s largest cities were designed along racial lines. This left severe legacy problems after democracy was achieved in 1994, as most of the population was not catered for in terms of decent housing. The country’s cities grew but were not supported by adequate housing policies.
After democracy when all South Africans gained the right to live in any area, many became in favour of home ownership. But a shift towards renting housing is happening, being driven by high consumer inflation, economic uncertainty and rising unemployment. Across income groups, more South Africans are renting, as their affordability has waned. Other people are choosing to use their incomes differently, wanting to spend on holidays and entertainment instead of putting millions into large family homes.
Demand for rental housing is expected to continue at high intensity as economic factors deter people from home ownership. Globally, demand for multifamily rental housing has climbed as renters have been priced out of the buying market by high property prices and rising interest rates. Apartment occupancy rates also tend to stay firm during economic downturns, as renters are disinclined to relocate and then opt to stay in rental housing longer than they otherwise would.
While there is no shortage of demand for rental housing, investing in it does come with challenges. It can be a complicated asset to manage when it reaches a large scale because there are so many unique tenants.
The different types of invest-able residential properties
Residential property types include sectional title apartments, freehold or full-title properties, short-term let properties, RDP housing, gap housing and other subsidised and affordable accommodation.
Sectional title describes the separate ownership of a unit within a complex or development. This contrasts with a full-title property, where the buyer has full ownership rights to a property, including the building and the land upon which it is built.
The types of new residential projects suggest that South Africans are buying or renting homes in communal estates instead of free-standing homes.
Developers have purposefully pursued projects which respond to challenges faced by South Africans. Complexes and gated estates have been built so that residents are able to live with dedicated security protecting them. These housing villages are managed by companies which provide services such as backup power when the country suffers from rolling blackouts and water and waste management. They also provide facilities which vary on how upmarket they are and their design, such as cafes restaurants, pools and cycling tracks. The likes of JSE-listed Balwin Properties, which builds and sells sectional title apartments, has launched a rental business in its complexes.
Attracting the appropriate investor
Who invests in residential rental real estate?
Most residential property in SA is owned by households and retail investors, which differs from other markets. For example, residential property accounts for a substantial 25% of the US’ listed sector. This is while vin SA, financial institutions and pension fund managers have not yet embraced residential rental property compared with other residential asset classes. There are only a handful of listed funds which specialise in residential property. Most of them are illiquid and smaller than other real estate investment trusts. Private landlords dominate residential property and vary widely in the size of their portfolios. This leads to a fragmented industry. Private funds are also not obliged to report detailed data about their portfolios.
How much of the SA property investment universe is residential property?
The USA has the largest commercial real estate industry in the world, worth about $21trn according to the National Association of Real Estate Investment Trusts (Nareit). Of this, about $4trn is residential property. Residential property makes up less than 2% of SA’s listed sector. The market capitalisation of the FTSE/JSE SA Listed Property Index is R242bn. The sector is mostly comprised of retail and office properties. The market capitalisation of the listed residential funds Transcend and Indluplace Properties, as well as the housing portions of SA Corporate Real Estate and Octodec Investments, is less than R4bn combined.
However, The Property Network (TPN) which collects data from 1-million rental units in SA, has reported that the combined value of all rental property in SA is over R800bn, which is twice the size of each of the office and industrial investment property sectors. The potential to grow an industry which delivers attractive long-term returns is massive.
Why residential funds have listed on the JSE?
Establishing exposure to residential property in the listed sector has been slow, with Indluplace Properties the first housing fund to list in 2015. Since then, Transcend Residential and Balwin Properties have listed with the former focussed on being a landlord and the latter on being a developer.
Today Indluplace owns properties worth R3.7bn but a market capitalisation of R892m. Many JSE-listed real estate investment trusts (Reits) are trading at large discounts to net asset value (NAV); 41% in Indluplace’s case. Carel de Wit, CEO of Indluplace says the company’s former parent, Arrowhead Properties, invested in residential property. Then it listed its residential portfolio separately under Indluplace. Property funds were enjoying a boom in listings as people wanted to own shares in Reits which must pay out at least 75% of their income as dividends.
Residential Reits in SA have provided income returns throughout market cycles. Other benefits of the asset class are that individual leases mean defaults will have less of a severe effect on the fund’s portfolio and managers can excel if they manage the churn of tenants well.
A negative is that it is difficult to pass inflation to existing residential tenants through rental increases, given their affordability. De Wit expects stronger income growth for residential property in 2023 and gradual capital investment in the asset class, which will see more residential developments.
International successes
Traditional property asset classes: offices and shopping centres are facing a downturn in terms of their returns attracting capital. Globally hot sectors include logistics, multi-family residential and warehouse space which could be used for filming streaming television and film. Offices and retail centres used to be dependable with lengthy lease terms especially during global growth periods.
But, post pandemic, the world is battling high inflation amid weak economic growth. Developed markets are not developing as many mega malls and office towers. Changes to lifestyles have meant people need less office space as more work from home and more people dwell in malls for shorter periods as they shop online.
Investors are therefore turning their money to residential assets as the US, Germany and others enter the golden age of multi-family property.
It is also difficult for many individuals to make a case for living in congested cities with a prohibitive cost of living when you can retain or find a new job that will allow you to work remotely. Working professionals have embraced new career opportunities and living flexibility, further causing homeownership rates to decline steadily.
The Future
These demographic trends, along with the imbalance of supply and demand in South Africa, are highlighting enormous opportunities for the residential asset class. Needing affordable rentable homes in an economy with a growing population may be crucial for the country’s social and economic progress. This asset class may hold long-term returns for investors.
Property Flash will continue to investigate the residential asset class in South Africa in further depth, across The Residential Rental Insights series. Keep on reading as we learn how people and institutions view residential property and the value which it can provide to investors.