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Low income residential development on the rise in South Africa

A living area in one of the converted low cost residential options in Germiston, JHB.

Demand for affordable housing for South Africa’s low and middle income earners is superseding supply, with industry experts predicting that the asset class will show excellent growth potential.

Due to South Africa’s history of racial divide, a shortage of affordable, entry level housing within urban areas exists and supply is expected to take many years before it catches up with the demand.
This is an asset class within the property market which investors have typically been reticent to invest in, leading to widening the supply and demand gap, said Ryan Wintle of Construct Capital, which specialises in providing development management services and funding solutions.

Construct Capital is converting old, economically unviable commercial buildings into low cost residential accommodation in Germiston, Randburg, Johannesburg CBD and Durban’s Point area. Average rentals are between R3 000 and R5 500 for flats ranging from bachelors to three bedrooms.

“Factors contributing to driving this demand include urbanisation, as rural South Africans move to bigger centres in search of work and a better life for themselves, as well as the cost of transport and more efficient travel times,” Wintle said. “As for all of us, time is money, and these properties are centralised and located in commercial areas. In some of these properties it is even viable to have a crèche, making the lives of working parents easier.”

In order to make a market related return on rentals it is imperative to effectively manage building costs of the conversion. However, it is equally important not to cut costs on items which can later result in significant increases in operational costs. “We use granite tops in our units as opposed to melamine which deteriorate quickly if tenants put hot items on the surface,” Wintle said.

“There is massive demand for affordable and safe residential accommodation, yet the traditional banks are cautious of funding these sorts of developments,” Wintle said. “We feel that this is due to two main reasons. Firstly the fact that the tenants can only be signed up once the development is complete means funding needs to be approved on a theoretical income stream. Secondly these assets are tenanted by numerous short term leases, as opposed to longer term stronger leases, which the banks currently perceive as riskier. This generally results in more equity being required to convert these projects.”

Despite these barriers, private investors are allocating capital to these projects, which show viable long-term potential. “This limits entrance to this market to those who have significant cash. Yet even with the equity requirements, these projects are drawing in lots of investors because of the good yields and a secure income stream.”

TPN credit bureau, who specialise in property rentals, said that at the start of 2014, 86% of residential tenants were recorded as being in Good Standing. Of this figure, 83% of tenants rented for below R7 000 a month. TPN’s Residental Rental Monitor for 2014 noted that the “sweet-spot” for residential rentals was the R3 000 to R7 000 rental category, “with 61% of tenants renting in this price range, resulting in a consistently strong demand for properties”.

Wintle believes that operational control is of utmost importance in order to make these types of properties viable. “If this type of asset is managed properly, it can provide a bullet proof income stream for the investor. Access control is critical and managing non-paying tenants very quickly is key; thus management needs to be very active.”

The property managers need to provide a safe and clean environment for tenants, keep out bad influences and ensure rent is paid. “It is more expensive to manage than other property classes; however this type of investment does provide a good and consistent return.”

Internationally, residential-focused property funds make up a large percentage of the listed property sector, however no such fund currently exists in South Africa. Recent reports in the business press are that a property loan stock company plans to list the first residential-only property fund on the JSE by the middle of this year.

“Previous residential listing attempts have been unsuccessful. A major reason for this could be investor perceptions, however these are changing. Construct Capital believes the time is ripe to see such a specialised residential fund listed and a new asset class created.”