Will 2017 see residential yields rise again?

In the 3rd Quarter of 2016, the revised FNB-TPN National Average Gross Residential Yield declined very slightly from the previous quarter’s average, after having risen in the 2nd quarter. The FNB-TPN Residential Yield dataset is the combined result of TPN rental data, along with FNB’s house price data and its Automated Valuation Model (AVM). The approach has been to take all of the properties for which TPN rental data exists, utilize the FNB AVM to estimate a current value on the property, and then to calculate the Gross Initial Yield on all such properties.

The National Average Gross Yield declined slightly to 9.06% in the 3rd quarter of 2016, from a revised 2nd quarter level of 9.11%. This comes after the 2nd quarter average had risen from 9.07% in the 1st quarter.

The Average Gross Yield had previously declined from a high of 9.22% back in the final quarter of 2013 to 9.07% by early-2016, driven lower by a period of solid home buying performance up until not too long ago, which resulted in solid house price inflation until the early stages of 2016.

After that 2nd quarter increase in the average yield, it was believed that it could be the beginning of a longer gradual rising trend in yields, given that many of the fundamentals pointed towards it. Interest rates had risen gradually from early-2014 to early-2016, and a multi-year economic growth slowdown since around 2012 had exerted downward pressure on home buying demand. By 2016, this had begun to exert some downward pressure on house price growth, and slower house price inflation that under performs rental inflation is exactly what is needed in order to lift yields and make it a more attractive buy-to-let buying opportunity.

But FNB’s expectations of rising yields proved to be a little premature, the 3rd quarter of 2016 data suggests.

Nevertheless, it is not believed that the 3rd quarter decline in the average yield is a cause to modify our expectations, and remain of the expectation that 2017 will be a year in which yields could rise more noticeably.

FNB’s reasoning is in part due to the fact that, according to the FNB House Price Index in the 4th quarter of 2016, FNB began to see average house price growth slow more noticeably. From a year-on-year rise of 4.6% in the 3rd quarter, average house price inflation slowed significantly to 1.9% in the 4th quarter of 2016.

That 3rd quarter average house price growth was very similar to the StatsSA estimate of 4.88% year-on-year inflation in average residential rental payments late in 2016. However, the 1.9% house price growth of the 4th quarter is noticeably weaker than that rental inflation estimate.

The result is that when FNB compiles their Average House Price-Average Rent Ratio Index from the 2 time series (almost the inverse of a yield calculation, but here FNB is not matching value and yield of each individual property), recent months have begun to show a decline in this ratio. This implies rental inflation noticeably outpacing weak house price inflation.

TPN’s estimates of annual rental escalations, having previously gone through a slowing period from 2014 to 2015, have more recently shown some mild strengthening in 2016. From a low of 2.8% year-on-year as at the final quarter of 2015, the average rental escalation had shown some moderate increase to 4.25% by the 3rd quarter of 2016.

In short, therefore, while FNB didn’t see a further rise in the Average Gross Yield on residential properties in the 3rd quarter of 2016, the 4th quarter house price growth slowdown suggests that house price growth in that quarter began to noticeably under perform various estimates for rentals, which point to rental inflation perhaps nearer to 5%.

Looking into 2017, FNB expects that average house price inflation will by and large under perform rental inflation in another tough economic year. FNB projects house price growth for 2017 to average around 3%, down from 5% in 2016, in lagged response to the economic growth slowdown and interest rate hiking of recent years up to 2016.

The result is expected to be some gradual increase in the Average Gross Yield for 2017, “gradual” being the operative word, from an expected average of around 9.1% at the end of 2016 to nearer to 9.3% by the end of 2017.

Read more here: FNB TPN Yields Outlook – 10th January 2017