Predicting the property market

Whilst most property investors define themselves as long term investors there is always an element of speculation in the human psyche. Naturally the high exit and entry costs serve only to stimulate the long term investment decision but even that mindset requires an element of prediction.

Will the area hold its value? How will the investment compare with others? Will the demographics of the area improve or decline? These are all vexing questions faced by both the commercial and residential property investors.

And then there is the general economy and the application of all the obvious economic indicators to the investment decision.

Perhaps the most difficult application of economic data is the lead lag dynamic so prevalent to the industry. The unpredictability of the economic cycle can catch even the most astute investor unprepared. The recent volatility of the oil price is but one example. Investors are asking themselves how a lower oil price will affect property prices. Firstly, there is the domino effect of the price of such a strategic commodity on the greater economy and questions around the sustainability or longevity thereof. Its common knowledge that the impact of fracking and shale gas in the USA has played a large role in the rapid decline of the oil price. The USA is now second only to Saudi Arabia in output. However given the high cost of extraction in the USA relative to the Middle East, a price of $65 per barrel appears to be the optimal sustainability factor for USA production, and we’ve seen the recent closing down of numerous wells as evidence thereof.

Combine this with the obvious political challenges in the Middle East, the apparent disharmony in the OPEC cartel (and the Saudi’s decision to keep pumping no matter what) as well as the uncertainties in Europe and Russia, together with the collapse of the Rouble and the impact on the volatility index becomes obvious.

But even if there was substantially more predictability, what are the impacts. What does a lower oil price mean for property outside of the normal macro-economic effects on currency prices, on interest rates, on supply and demand, on business confidence, on the retail sector, on consumption, on manufacturing?

Will residents be more inclined to live further from work due to a lower oil price? How will this affect the investment decision? Will the lower oil price have the same effect as an income tax or interest rate cut by stimulating consumption ,which stimulates retail, which stimulates manufacturing (or imports!!!) which stimulates warehousing opportunities and office space for the accountants to count the money!!!

There are more questions than answers. So what advice are property and investment practitioners to give to their clients about the identification of property sectors and the optimal investment choice.

Ensure there are tenants in place, ideally good covenants with reliable payment histories. Purchase a property on an attractive forward yield and sustainable escalations with upside potential in a decent area .If you are leveraging the property and have fears of interest rate increases, cap your interest rate and protect yourself.

Whilst the above-mentioned states the obvious risk management criteria, perhaps the most challenging factor is the identification of core segments of scarcity and obvious segments of oversupply. Both office and retail space reflect oversupply in the short to medium term, whilst the drum beat of residential and student accommodation beats ever louder.

Vast shortages of student accommodation are linked largely to geographic proximity to centers of learning, the scarcity of which simply pushes up the price of land for developments and the rentals of accommodation, but there is a natural affordability threshold which investors/developers need to be wary of.

Likewise the pent up demand for residential accommodation and restrictive lending by financial institutions sees a shift of institutional property funds away from traditional commercial investing towards residential developments.

In conclusion, there appears to be strong shift in investment thinking as a natural response to market trends and economic realities.

 

Author: Don Clark Commercial and Industrial Broker Manager, Permanent Trust Management (Pty) Ltd