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Shift from residential a global trend

Soaring property prices in Cape Town could see residential property investors turning their focus to better-priced commercial real estate, experts say.

This shift is one seen across the globe and is in full swing in places such as Auckland, New Zealand, where surging capital values of property have seen traditional residential investors turn to commercial real estate.

According to commercial property agency Collier’s International, which also operates in South Africa, a growing number of entry-level individual investors and family trusts in Auckland are seeking to invest in commercial real estate which, in comparison to residential property, is becoming more appealing and affordable.

In the past 12 months, the team has seen an increase in inquiries from investors who would have previously invested in residential property, says Gareth Fraser, Auckland director of Colliers International’s investment sales team.

“Until recently, these investors would have considered commercial property to be out of reach because of residential property still being relatively affordable. However, massive capital value growth has pushed median house prices well over A$1million (about R9m).

By comparison, entry-level commercial units can be bought for as little as $300 000.”

Along with the lower cost of entry, Fraser says prospective investors are also attracted to the competitive yields that commercial property investments offer.

In Cape Town, owners of residential property have seen an increase in the value of their homes of 50.4% over the past five years, according to FNB data, and although house price growth has slowed dramatically, property in the Mother City, and parts of the province, still remains largely unaffordable. 

Private residential investors looking to invest in commercial property should consider industrial and office properties as they are not over-valued, says Erwin Rode of Rode & Associates,

“This is in contrast to residential properties that, from an asset allocation point of view, implies one should consider non-residential properties. Sectional title commercial properties are typically available in affordable chunks, although the initial income yields tend to be similar to those of two-bedroom flats.

“Also, banks in South Africa are generally more conservative with respect to the loan-to-value (LTV) ratios applicable to non-residential properties. Thus, assume you will get no better than an LTV of 60%. The higher the mortgage loan ratio, the more likely it is you will be in a negative cash flow position from year one.”

Explaining the LTV ratio, Rudi Botha, chief executive of bond originator BetterBond, says this is basically the requested loan amount expressed as a percentage of the purchase price – or as a percentage of the appraised value of the property, if this is different from the purchase price.

For example, if a property costs R2million and the buyer is putting down a R200000 (10%) deposit, the loan required would be R1.8m, so the LTV would usually be 90%.

“However, if the bank’s evaluation of the property is only R1.9m, the loan of R1.8m would equate to an LTV of 95% as far as the bank is concerned, and that could result in the application being turned down. This once again underlines the advantage of saving up the biggest deposit possible.”

The bigger the deposit and the lower the LTV percentage, the more attractive the loan from the lender’s point of view, “because the more ‘skin in the game’ that prospective borrowers have”, the lower the risk of them defaulting. For this reason, most banks are prepared to negotiate lower interest rates on low LTV applications”.

Although residential properties are expensive in Cape Town, Rode says buyers of commercial sectional title properties, like those who invest in residential sectional titles, should have knowledge of related legislation and accounting before considering taking this step.

“Buying a sectional title property – be it a flat or industrial property – requires some knowledge of the legislation surrounding sectional titles, as well as a little accounting knowledge. The last thing you want to do is to invest in a body corporate that is poorly managed. Thus, in the case of a sectional title property, do ask for the last two years’ financial statements. If in doubt, get advice from a lawyer, accountant or auditor.”

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