Investors are expected to turn increasingly from residential to commercial property as house prices continue to soften and the long-awaited recovery in the office and industrial letting markets gathers pace.
Speaking at a conference on the prospects for property in Johannesburg earlier this week property valuator Erwin Rode said while houses are now fully priced the upswing in commercial property has only just begun.
Rode suggested that now is a good time for investors to sell buy-to-let flats and invest in non-residential property, particularly offices. Office vacancies have recently dropped to around 5%, down from 12% three years ago. Rode said if the old rule of thumb still holds true that real rental growth kicks in as soon as vacancies dip below 5%, the office sector is in for a huge boom.
FNB property strategist John Loos echoes a similar sentiment in his latest industry report. Loos says developers and investors will start switching from residential to commercial property as the latter is just beginning to move from a ``jog to a sprint``. Auction Alliance CEO Rael Levitt says this is already happening. Demand for commercial buildings from smaller, private investors in particular has risen sharply in recent months.
Levitt says this trend is driven by the fact that investors can still earn close to double the rental returns on commercial property than that generally available in the well-supplied residential letting market. Net rental yields on smaller strip shopping centres are around the 8% to 10% level while factories/warehouses and smaller office blocks (generally older, B-grade buildings) offer yields of 11% to 12%.
However, buying a commercial property with borrowed money is easier said than done. Levitt concedes that banks are generally still cautious to finance commercial buildings because many had burnt their fingers when the market was in a slump in the Eighties and Nineties.
Most banks will only extend a loan on a commercial property for 10 to 15 years compared to the average 20-year loan repayment period offered on residential properties. Commercial property buyers also need to put down relatively hefty cash deposits of at least 20% to 30% while 100% loans are readily available for homebuyers.
Another issue is that banks are generally too conservative in their valuations of commercial buildings. Valuation Alliance MD Barry Kaganson says lenders are struggling to adjust to fast rising property prices and are often prejudicing borrowers because of overly conservative or outdated valuations.
Says Kaganson: ``In the past, market statistics of three to six months old were considered recent and were acceptable as the basis for most credit decisions. That is not good enough anymore. Now these figures represent low-ball estimates, often equal to only 20% off the actual market-related value of a commercial building.'
But Levitt and Kaganson agree that as the lending sector becomes increasingly competitive on the back of rapidly rising commercial property values, banks will have no choice but to adapt to a changing market.