Residential Rental Yield Review – Yields remain on a declining trend in Q1 2016

After the -2008/9 Recession, the housing market’s gradual recovery of subsequent years finally gained enough momentum to begin to compress yields once again as from 2014.

By late-2013, home buying demand had reached what was arguably its strongest post-recession levels, with interest rates still at a multi-decade low where Prime Rate had bottomed at 8.5%.

One would perhaps have expected to see yield decline resume far sooner than 2013, given that interest rates began to fall as far back as late-2008, but while residential demand had indeed reacted quite swiftly to rate cuts, strengthening from 2009 onward, it took a lengthy time for the home buying market to build up to “full steam”, with much of the demand only coming into the market once there had been sufficient evidence of market strength for a considerable period.

Such are the leads and lags.

And so, from the 1st quarter of 2014 to early-2016, FNB had the lagged response to earlier home buying demand build up, in the form of a period of a mild yield decline.

From a high of 8.58% in the final quarter of 2013, the National Average Gross Yield has declined to 8.34% in the 1st quarter of 2016.

In January 2014 the Reserve Bank (SARB) began to hike interest rates gradually, and has continued up until early-2016, which we had expect to boost the rental market and possibly begin to raise yields. However, the pace of interest increase has been very slow and mild in magnitude to date, and doesn’t appear to have yet done much for rentals to date. In addition, we have a weak economy bordering on recession, so perhaps rental demand has been stifled as a result. Tenants and aspirant tenants also experience the negative impact a deteriorating economy.

Nevertheless, after a 2 year decline in yields at a time when interest rates have been rising all the while, we would ultimately expect a turn in the trend towards rising yields, but perhaps our expectations were a bit premature.

FNB emphasizes that the yields calculated in this report are gross yields, meaning that landlord operating costs associated with the property have not yet been included in the calculation to get to a net initial yield.

Rode and Associates have in the past suggested that, as a rough estimate, one could take 1.5 percentage points off the gross yield to estimate a net yield. If one were to do this, it would leave the net yield at around 6.84%. Such a yield would, for many, still be below the cost of finance, given a most recent prime rate of 10.5%, and the average home loan rate somewhere above prime, and therefore perhaps still not overly attractive.

This perhaps explains why the estimated percentage of home buyers being buy-to-let buyers remains mired in single-digits at 7.6% in the 2nd quarter 2016 FNB Estate Agent Survey.

However, the yield versus interest rate on mortgage credit is not the only variable determining buy-to-let attractiveness. It is also important to evaluate the yield versus the investment risk.

In this regard, FNB has begun to see some increase in tenant risk in recent quarters, reflecting the onset of tougher economic times.

This is reflected in the form of a decline in tenants recorded as being “in good standing” regarding their rental payments, expressed as a percentage of total tenants on the TPN system. From a post-2008/9 Recession high of 86% reached at stages of 2013/2014, the percentage of tenants in good standing has receded mildly to 82.2% by the 1st Quarter of 2016.

It would appear, therefore, that gradual interest rate hiking, and 4 years of broad economic growth slowdown to date, taking job creation and household income growth weaker, have begun to take a toll on a portion of the rental tenant population as could be expected.

This figure is something to watch closely, because a dip to 71% of tenants being in good standing back in 2009 indicates just how sensitive tenants are to economic cycles and interest rates (interest rates having peaked at 15.5% prime in 2008 and the economy experiencing a recession through late-2008 and the 1st half of 2009). The deterioration to date this time around has been far more modest thus far. Perhaps cushioning the blow this time around is a far more gradual interest rate hiking cycle compared to that previous one. Realistically, though, many tenants cannot defy rate hiking and economic decline indefinitely, and should the country indeed fall into recession, this percentage could be expected to decline further.


With regard to the direction of residential yields in 2016, much will depend on the movement of interest rates. In the very near term, given that our estimate of national house price inflation has recently been around 7% year-on-year, while StatsSA still puts average rental inflation at a lower 5.18%, yields could still decline a little further.

In addition, TPN’s National Average Rental Escalation rate was a lowly 3.3% year-on-year in the 1st quarter of 2016, supporting the possibility that decline in the National Average Yield is not quite over yet.

However, FNB would ultimately expect some lagged response of the market to rising interest rates, in the form of a rise in yields, in the not too distant future. We are not of the view that average house price growth can sustain levels around 7% under current economic conditions, and would expect it to recede to low single digits as we head nearer to 2017.

In addition, there are some signals emanating from our FNB Estate Agent Survey that rental demand could be strengthened in the not too distant future.

The 1st such signal emanates from 1st time buyer demand. In tougher times, aspirant 1st time buyers can hide out in the rental market in larger numbers, such as happened around 2008/9, where we saw very low percentages of 1st time home buying. This may just be starting to happen, with 1st Time Buying at an estimated 21% of total home buying as at the time of 1st quarter 2016 being noticeably lower than the 2014 high of 28%.

While 21% is still a high percentage for 1st time buying, the broader trend unfolding appears to be a declining one.

A 2nd potential source of rental demand emanates from households under financial pressure. Here, too, we may be starting to see signs of increasing support for rental demand. Those sellers selling in order to downscale due to financial pressure remain relatively low at an estimated 14% of total sellers. However, this remains up from lows of 11% reached at stages of 2014 and 2015, and may be an early hint of the start of a rising trend.

In addition, in the 1st quarter 2016 FNB Estate Agent survey, the agents estimated that the percentage of such sellers whom they believed would “rent down” as opposed to “buy down” has risen to 53%.

In short, rental demand’s time doesn’t appear to have come in a significantly bigger way just yet, but there are signs that we may seem some strengthening to come. We would also expect some weakening in home buying demand and therefore house price growth.

Therefore, while in the immediate future, a further decline in average yields may be seen towards 2017, this declining trend may slowly begin to turn, as one would ultimately expect in lagged response to over 2 years of rising interest rate.

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