Sellers are not adapting to changing market conditions

By Andró Griessel

29/7/2023

The residential property market is currently so quiet that you can hear the crickets chirping.

In my opinion, the majority of residential property sellers (as well as their agents, unfortunately) fail to consider the evolving circumstances of the last 18 to 24 months. This oversight could potentially result in an overly simplistic valuation process.

Property is an interest rate-sensitive asset class, and the prime lending rate has increased from 7% in September 2021 to 11.75% today.

However, I fail to observe any adaptations made by sellers and their agents to account for this in property listing prices.

This explains the notable decline in successful transactions in the property market at the moment.

Unlike in the listed space (stocks and bonds), unlisted assets (such as residential property) slowly adjust to changed circumstances, precisely because there isn’t an effective price mechanism present.

What follows is a case study of a property for which I provided guidance to a client (the buyer). It may resonate with many people who are currently engaged in the process of buying or selling property.

The property, located in the Northern suburbs of Cape Town, is on the market for R2,695,000. The agent conveyed to the potential buyer that the owner would potentially entertain an offer of R2,550,000 (probably to pocket R2,450,000 net).

Valuation process

I’m not entirely clear on the method by which the owner and agent determined this particular price. However, based on numerous interactions I’ve had with agents over the past few years, the valuation process, as I’ve observed, typically unfolds as follows:

• The property’s CMA and Lightstone reports are procured. These two central databases contain details about property transactions and offer valuable insights about the subject property as well as other properties in the vicinity, including their respective selling prices.

• Afterward, the agent estimates changes in the price based on their own knowledge of the area, recent sales, the condition of the property compared to others, and the prices at which similar properties were selling at that time. This helps determine a realistic selling price.

• In general, an extra amount is factored in to cover the agent’s commission, and occasionally a little more is included to allow the buyer some room for negotiation.

In my opinion, the following is lacking in the price discovery process:

• No consideration is given to inflation adjustments. It’s not accurate to take the sales price of a neighboring property that was purchased for R2,295,000 in 2021 and apply it as the property’s current value. This value should be modified to account for inflation first. During this particular period, the annual inflation rate was 6.67%, indicating that the property’s value, adjusted for inflation for valuation purposes, should be R2,615,752.

• Nonetheless, back in 2021, when the prime lending rate was 7%, the individual who bought that house could manage a monthly mortgage repayment of R20,280 based on today’s value adjusted for inflation.Given the prevailing interest rate of 11.75%, this very same person could only afford to pay R1,871,345 for the property from an affordability point of view.For the most part, property transactions are still influenced by what’s affordable – meaning you or your bank determine the maximum sum you can manage.Even if we assume that the buyer received a 7% net increase in income for 2 consecutive years, they would only be able to pay R1,871,345 for the same property they could comfortably spend R2,295,000 on just two years prior. This translates to a decrease of 18.46%.

• The above are two important quantitative measures, which can be tweaked here and there.Larger properties, for instance, typically tend to sell for a lower per square meter price compared to smaller properties as a general trend. Additionally, the concept of the time value of money comes into play.Numerous sellers are willing to take a risk and gauge the highest possible offer, but for every month your house remains unsold, you essentially need to demand 0.83% more just to maintain the same position as if you were earning a 10% return on your money elsewhere.
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  While this might not appear significant, the likelihood of needing to lower your price, as time progresses, grows, let alone raise it.

• Qualitative aspects also have a significant impact, and this is an area where seasoned agents tend to excel.They often have a keen understanding of how features like quality finishes, proximity to schools, additional outdoor space, and so on, contribute to the overall value of your property.

Returning to the case study, following a series of quantitative adjustments, I arrive at a property valuation of R2,197,000. This value contrasts with the listed price of R2,695,000.

Based on the information I’ve gathered from my client, the condition of the house ranges from average to slightly below average. For this, it would be prudent to subtract an estimated sum (reflecting the anticipated cost of bringing it up to standard).

If I adopt a conservative estimate of R197,000 for renovations, then the “offer price” would be an even R2 million. Factoring in an agent’s commission of 4% to be subtracted from the offer, the seller’s net proceeds would be a mere R1,920,000. This figure is 22% lower than their initial asking price.

My advice to my client

• It’s wiser to make 10 offers that might not get accepted than to overpay by R300,000 or R400,000.

• Follow a thorough process, make your offer, and be prepared to move on if it’s declined. This holds particular significance when dealing with investment properties.

I think the current sluggish property market will continue until one or both of the following situations occur:

• a realization that there must be a decrease in prices leading to an actual price decline, or

• a swift return of interest rates to 2021 levels.

To be honest, I don’t see the latter happening. So, in my view, we’re left with either prices going down or a long period where not many properties are sold, and prices stay the same – which is basically the same as prices going down over time.

There are also other things to consider, like the semigration of people moving from the north to the Cape. But keep in mind, inflation has taken significant bites out of the disposable income of especially middle-class households over the past two years. This makes it even harder to afford properties.

As always, my advice is simple: Focus on a thorough process, and the results should follow.

Andró Griessel is a certified financial planner and managing director of Woodland Wealth. Contact him at info@woodlandwealth.co.za.

Although all possible care has been taken in the preparation of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone who intends to take any financial action based on this document is strongly advised to first consult with his/her personal financial advisor. Woodland Wealth is an authorised financial service provider with FSP no. 5966.