Political Blogs - Blog Catalog Blog Directory

Sunday, 08 February 2009

Why the South African property market is a huge bubble

Influential publications such as The Economist have long held that the true economic value of a home, if a rational economic approach was the only consideration, would be the value of the rental you could obtain by owning the home plus the capital growth over time.

My contention is that the South African property market is one enormous bubble, which, in line with other international property markets, is due for a huge correction. There is no doubt that it is a bubble waiting to burst.

Let's do the math.

The average house price in South Africa is around R950,000 (more or less US$100,00.) If you were to purchase a home and obtain an 80% bond, your monthly repayments would be around R9400 per month.

Average rentals obviously vary per area, but a monthly amount of R5500 is a fair estimate of a rental for the size of house you could buy for R950,000. It should immediately be apparent that you are losing around R4000 per month, if you purchased the house as an investment, intending to rent it out.

But wait, some would say. The house is a capital asset that appreciates over time. OK, let's take 5% per annum as a long-term average capital appreciation rate. At the end of your 20 year bond period, your home would be worth R2,5 million rand. You would have paid R2,26 million in bond repayments, but would have received R2.18 million rand in rental income, assuming you increased the rentals by 5% per year as well.

Your net position after 20 years is: R2.5 million plus R2.18 million minus R2.26 million which adds up to R2.43 million. There is a problem, though – this amount is of course excluding taxes – rental income is taxable, and you'd have to pay municipal rates and taxes too.

However, if you'd merely invested your money in a bank account, at 9% interest, you'd be R6 million richer! You would have had no administration to worry about, no maintenance, and no municipal taxes. In short, buying a property at the current prices would be an extremely poor investment, far, far worse than just leaving your money in the bank, which is also not the best investment strategy.

The above of course also implies that properties in South Africa are still vastly, immensely overpriced. I would say that even halving the price of the R950,000 house would still result in a price that is too high.

There is no way that, given the current rental market, that a R950,000 house is worth that amount in economic terms, no matter what estate agents try to tell you. You would be far better off from a financial point of view renting a house. Do not even consider buying a house as an investment, because it is clear the South Africa's property market is in the throes of a huge, unsustainable bubble.

If you want a good investment, almost anything is better than South African residential property at present. Put your money in the bank, for example. At least that way, you won't have the headache of tenants wrecking your property.

blog comments powered by Disqus
free counters Afrigator