The Cost of Living

We all know that prices seem to rise continuously, and that just to make ends meet is a never-ending challenge. But what is the true “cost of living” and how is it measured?

One of the tools is the well known CPI or consumer price index.  This index is calculated by a government department called Stats SA, which uses various expenses such as housing, food clothes and transport, and then attaches a different importance (or ‘weight’) to each one when combining them into the end result which we see on the TV and read in the newspaper.

With effect from January 2009,  the percentage weighting in the CPI attributable to housing has risen to 23.2%.    One of the sub-components of housing is “owner-occupied housing”.  This was previously measured as being equal to the interest rates on mortgage bonds.  This has been replaced by “Owners equivalent rent”   or  “OER”.  This is the rent paid by that quarter of SA households who rent rather than own their own homes. In essence OER is the rent a homeowner is foregoing by living in his home and not letting it out to a tenant.

With the focus now on rentals rather than mortgage bond interest rates,  property owners and those who wish to buy property will realise that income (rather than capital growth) is the most important factor in property investment. Studies have shown that rental income makes up to 50% of the total investment return (yield) on residential property over a 5 year period. In commercial properties, rental incomes are responsible for up to 85% of the yield over 18 years.

By focusing on the rental income which you can get by letting out a house,  the capital growth (the house price increase above what you paid for it) becomes far less important,  and this will encourage potential house buyers not to chase prices up unrealistically.  What is important is what a tenant can afford to pay by way of monthly rent.  If the house owner wishes to let out his house for a return of 8% of the current value of then house,  but finds that this rental figure is too high for the average tenant to pay, then the chances are the owner has overvalued his house. A potential buyer should ask the same question to see if the price being asked is realistic, assuming a return of 8%, for example.  Thus a rental of R5000 per month or R60 000 per year divided by 8% means the house is worth R750 000. 

One thing on which all parties agree is that if you owe money on a mortgage bond, then any extra money you pay into your bond account is an excellent investment since you’ll save a lot of  compound interest over the long period of the home loan.  So, pay off your mortgage bond first before considering whether to buy a second property or shares on the JSE.

Clive Hill | Financial Services Manager