FNB PROPERTY BAROMETER

HOME LOANS DIVISION FNB PROPERTY BAROMETER 4 TH Quarter 2009 - Ending the last decade on a strengthening note, but financial stress and affordability issues are far from over PROPERTY AND MORTGAGE MARKET ANALYTICS 28 January 2009 PROPERTY AND MORTGAGE MARKET ANALYTICS JOHN LOOS: FNB HOME LOANS STRATEGIST 011-6490125 John.loos@fnb.co.za EWALD KELLERMAN: PROPERTY MARKET ANALYST 011-6320021 ekellerman@fnb.co.za The information in this publication is derived from sources which are regarded as accurate and reliable, is of a general nature only, does not constitute advice and may not be applicable to all circumstances. Detailed advice should be obtained in individual cases. No responsibility for any error, omission or loss sustained by any person acting or refraining from acting as a result of this publication is accepted by Firstrand Group Limited and / or the authors of the material. First National Bank a division of FirstRand Bank Limited. An Authorised Financial Services provider. Reg No. 1929/001225/06 CONTENTS 1. Summary 2. Demand for Property Still rising but the pace of increase has slowed 3. Residential supply conditions Are oversupplies a thing of the past? We think not yet 4. Demographics and Property 5. The changing nature affordability continues to militate in favour of smaller-sized homes, but not just anywhere 6. Conclusion 1. SUMMARY The 4 th quarter FNB Property Barometer survey of a sample of estate agents highlights some of the dominant issues for residential property in both the short and long term. In the short term, its latest results point to further very slight strengthening in demand, but also that the pace of increase in demand may be starting to taper, posing the question as to how long the current recovery will still continue, especially given a lack of further interest rate cuts.. The demand activity rating, provided by the agents, shows an almost sideways movement in activity levels from a previous quarter s level of 5.65 in the previous quarter to 5.68 in the final quarter of 2009. Year-on-year growth in activity is still substantial at 23.7, but this is down on the previous quarter s 36.8, which may well be an early sign that activity will find a higher plateau at a later stage in 2010, as last year s interest rate stimulus starts to wear off. The highly-cyclical first-time buying component of total buying has increased in importance, but low yields and a lack of capital growth appear to be keeping buy-to-let activity subdued. The second key issue highlighted by the Barometer results relates implicitly to an oversupply of property, which is sustained by unrealistic pricing in many cases as well as financial pressure on households. Agents still report widespread lack of realism in pricing, with the overwhelming majority of sellers having to drop their asking price. However, there appears to have been some improvement in this regard, as they simultaneously report the second successive quarter of substantial decline in the average time that a property is on the market prior to being sold, from a 2 nd quarter peak of 21 weeks and 1 day to 13 weeks and 2 days in the 4 th quarter. Agents also continue to report widespread financial stress. They claim 24 of sellers being those that are selling in order to downscale due to financial pressure. This has improved from above 30 earlier in 2009, but is still troublesomely high. A third focal point is that is the demographics of buyers. Racial transformation remains an ongoing issue for all sectors of the economy, and its progress can to a degree be measured in residential buying activity. In 2009, the percentage of buyers that the agents estimated to have come from the so-called Black population group amounted to 29.5 (Bear in mind that the survey is dominated by former White Suburbs ), slightly lower than the 30 of the previous year, but this group has made the most gains from its 23 of total buyers in 2005. The so-called White group by comparison saw its percentage of total buying shrink from 57 to 53 from 2005 to 2009, while the smaller Coloured and - 1 -

Asian groups remained relatively stable. The trend is not surprising, given that the Black group has grown its disposable income the fastest off the lowest per capita base. Finally, the Barometer survey indicates that in the past 2 quarters only a minority of agents now believe that incomes are far behind property price levels, i.e. they believe that in-affordability is significantly less of an issue compared to the first half of last year. This is probably more to do with interest rate cuts, along with some house price deflation, rather than with any strength in income growth. While we agree with the agents views regarding an improvement in the traditional measure of affordability, which largely looks at house price relative to income, while also throwing the cost of credit into the mix, we nevertheless believe that affordability will still be the key issue in the current decade, but in a very different form. The traditional measure of affordability, i.e. home price versus income, is perhaps no longer as important as a year or two ago. The cost of servicing debt, while still high and troublesome due to the sheer size of the household debt burden, has also declined mildly in importance. Coming to the fore, though, is the new affordability challenge in the form of a sharp increase in certain costs related to owning and running a home, most notably Eskom tariff increases for the time being, but don t count significant rates, water and sewage cost increases out as other revenue shortfalls and infrastructure backlogs need to be financed. Then there is the issue of transport congestion and the need to shift towards public transport. Again, somebody will need to foot the bill for such services, which often require state support in some form or another. These are the affordability issues that look set to dominate the residential space as a new decade begins. They militate in favour of smaller-sized homes, smaller-sized stands, less luxuries attached such as swimming pools, a further reduction in live-in domestic worker quarters, and possibly a reduction in the use of domestic workers themselves. Yes, there s even a potential employment impact. These new affordability issues also heighten the importance of location, with location in relation to state-of-the-art public transport set to be crucial, distance from major business nodes, and proximity to good schools coming even more into play. If the above factors aren t enough to drive densification, government may have to promote densification through policy, as a means to making mass public transport pay for itself in future. But with densification comes an increasing shortage of private space, too. The new sought-after commodity which may strongly influence property values in future years is wellmanaged urban parkland, already in short supply in Gauteng s cities, and location relative to this is expected to be the new property plus-point. The current decade thus looks set to be about affordability all the way, but it is a very different affordability issue. Government would do well not to evaluate each application for a tariff increase (currently it is Eskom under the spotlight) in isolation, or solely on what the increase would do to short term economic growth or inflation. The potential impacts go far further. The household sector has to adapt to this new affordability issue by changing its living patterns. If the various utilities, along with councils, increase their rates and tariffs significantly in the coming years, urban planners and implementers need to be ready for the impacts of a possibly more rapid pace of urban densification.

2. DEMAND FOR PROPERTY STILL RISING, BUT THE PACE OF INCREASE HAS SLOWED The main FNB Property Barometer survey question relates to the level of demand activity, and agents are asked to rate the level of demand that they experience on a scale of 1 to 10. After a rise from a historic low of 4.1 in the third quarter of 2008, to 5.65 by the 3rd quarter of 2009, the 4th quarter level came in at 5.68, an almost unchanged level. Therefore, while the improving trend continues, the marginal rate of improvement possibly reflects a market constrained by a slow economy, and a highly-indebted household sector unable to respond in dramatic fashion to the big interest rate cuts earlier in 2009. Nevertheless, despite the negative factors stacked against the market, last year s interest rate cuts, along with some moderate relaxation in banks lending criteria, has made some difference. Level of Activity 8 7 6 5 4 3 2 1 0 Residential Property Confidence Indicator 7.63 7.66 7.5 6.73 7.32 7.44 6.75 6.06 5.83 6.33 6.33 5.45 5.99 6.69 5.78 5.29 5.09 4.96 4.42 4.13 4.59 4.8 4.79 5.65 5.68 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2003 2004 2005 2006 2007 2008 2009 Not Very Active Stable Active Very Active One needs to be cautious in viewing the activity level data, as seasonal factors can play a role from time to time. One manner of eliminating seasonal factors is to calculate the year-on-year percentage change in activity levels, thereby comparing the rate of change in activity with the same quarter a year before. 40 30 20 10 0-20 -30 Rate of Change in Demand Activity Levels according to FNB Property Barometer 2005 2006 2007 2008 2009-10 After seeing a strong growth rebound during the 3rd quarter of 2009, recording a year-on-year rate of 36.8, we have witnessed a slower growth rate of 23.7 in the 4th quarter. Admittedly, the 3rd quarter 36.8 rise came off a lower base than the 4th quarter growth rate, but it is nevertheless expected that growth in activity will begin to taper off as 2010 progresses and the big interest rate cutting stimulus of 2009 wears thinner. Level of Residential Demand Activity - y/y

There was a decline in the percentage of estate agents expecting activity levels to increase further in the next quarter (1 st quarter of 2010), from 61 in the previous quarter to 52. One should note, however, that seasonality in the 1 st quarter is the major factor influencing perceptions of near term future activity levels, so this reading remains positive, and well-higher than the 41 for the same quarter a year ago. Seasonal factors aside, survey respondents expectations are primarily shaped by their experience of a widespread positive household sector sentiment (Could the World Cup play some role in this?), which now outstrips the negativity so prevalent not so long ago, while relatively low interest rate levels are largely seen as still being a positive factor for the market. The third major factor is a more relaxed lending stance by banks. 80 60 40 20 0 FIRST TIME BUYING BEGINS TO SHOW A MORE NOTICEABLE RISE IN IMPORTANCE First time buying activity First time buying, expressed as a percentage of total buying, has started to show a noticeable increase. From 14 of total buying two quarters 30 ago, the percentage of first time buyers had risen to an estimated 19 by the 4th quarter of last 25 20 year. This group probably benefits more than many others from banks recent relaxation of deposit 15 10 5 requirements on home loans, as these buyers are probably a low savings group even by South Africa s weak savings standards. Any economic recovery would also be positive 2005 2006 2007 2008 2009 news for this group, as many first time buyers are First time buyers expressed as a percentage of total buyers Smoothed also relatively new entrants to the job market, a process that must have been slowed by the recent recession. This source of demand is typically more cyclical than the overall market, and it is expected to rise to a higher percentage of the total in the coming quarters. BUY-TO-LET BUYING REMAINS IN THE DOLDRUMS, WITH YIELDS STILL LOW Proportion of buyers buying to let The Buy-to-let Market has showed no significant improvement when its activity is expressed as a 30 percentage of total activity. Estate agents surveyed believe that buy-to-let buying made up 25 13 of total buying in the 4th quarter, which is unchanged from the 3rd quarter of 2009. This 20 ongoing weakness is hardly surprising in this market segment. Bank credit criteria remain 15 relatively conservative compared to a few years ago, the household sector s real disposable 10 income has been under huge pressure during the 59 Percentage of Estate Agents expecting Activity Levels to Increase 24 32 31 37 19 42 2006 2007 2008 2009 35 25 19 48 36 41 46 61 52 Factors that influence perceptions of future activity levels Seasonality Consumer Positive Sentiment Interest rates More Relaxed Lending Stance by Banks Stock Issues General Pessimism NCA Pricing and Affordability Strict Credit Environment Buyer's Market Area Specific Issues Other 0 10 20 30 40 5 2004 2005 2006 2007 2008 2009 Percentage of total buyers buying to let Smoothed

recession, and household sector existing indebtedness remains high. In addition, yields on residential property are generally low, which implies that market rentals generally don t cover the full bond repayment, while for those potential OF OWNERS BOND REPAYMENT buy-to-let buyers who get excited about COVERED BY RENTAL RECEIVED capital growth, there isn t much of that yet. The table to the left provides estate agents 20 or Less 40 50 55 60 65 70 75 80 90 95 100 AVERAGE = 60 0 2 20 27 27 24 0 0 responses as to what percentage of home owners bond repayments would be covered by the rental received on homes in their areas. The biggest percentage of estimates centres around 60-75 of the bond repayment being covered, with zero percent of estimates putting the bond cover above 90. 3. RESIDENTIAL SUPPLY CONDITIONS ARE OVERSUPPLIES A THING OF THE PAST? WE THINK NOT PRICING STILL WIDELY UNREALISTIC, BUT IMPROVEMENTS ARE NOTICEABLE AS DEMAND PICKS UP Indications are that there remains a widespread lack of realism amongst sellers in the market, but that it is improving. The 4 th quarter Barometer saw the estimated percentage of sellers required to drop their asking price in order to sell rise from 86 previous to 89. However, we admittedly do not know by how much the average price had to drop, and this may have changed over time. The indicator that does point to an improvement in realism, however, is the estimate of the average time that a property is on the market before being sold. This has dropped significantly from 21 weeks and 1 day just 2 quarters prior, to 13 weeks and 2 days by the 4 th quarter of last year. 90 70 50 30 10 Proportion of properties sold at less than asking price 2004 2005 2006 2007 2008 2009 Percentage of properties sold at less than asking price Smoothed Average time that a property is on the market 2 2005 2006 2007 2008 2009 Weeks and days that the average property is on the market before being sold Smoothed WIDESPREAD FINANCIAL PRESSURE STILL STRONGLY EVIDENT, ALTHOUGH THE SITUATION IS IMPROVING The table below, regarding the reasons for selling, shows survey respondents still being of the belief that selling in order to downscale due to financial pressure is the most important reason for selling. 24 of sellers were believed to be selling in order to downscale due to financial pressure, and this percentage reaches as high as 30 in low income areas, suggesting that financial strain is higher amongst lower income earners. By contrast, those selling in order to upgrade amount to a far lesser 13, according to the estimates. High Net Upper Middle Lower Total Reasons for selling (As of Total Sales) Worth income income income Downscaling due to financial pressure 24 18 19 29 30 Downscaling with life stage 17 19 19 16 12 Emigrating 7 9 8 6 4 Relocating within SA 7 7 7 6 7 Upgrading 13 12 16 12 15 Moving for safety and security reasons 11 13 11 10 9 Change in family structure 16 16 16 15 17 Moving to be closer to work or amenities 6 6 3 7 8 Weeks and Days on the Market 22 18 14 10 6

The left hand graph below, however, shows that the percentage of sellers selling in order to downscale has declined from a peak of 32 in the 2 nd quarter of 2009, while there has been a mild increase in those selling to upgrade. The two together suggest some improvement in the financial situation of the household sector as a whole, although this is probably largely due to interest rate cuts, and not due to any real growth in disposable income. 32 24 16 8 Emigration selling of residential property 0 Q4-2007 Q2-2008 Q4-2008 Q2-2009 Q4-2009 Emigration selling, which reached problematic proportions in 2008, appears to have stabilised after a steady decline, and in the 4 th quarter of last year showed a very slight up-tick from 6 of total selling in the previous quarter to 7. A 1 percentage point increase is not meaningful, though, and does not yet point to any renewed rising trend. 4. DEMOGRAPHICS AND PROPERTY INCOME AND DEMGRAPHIC FORCES SHIFTING THE COMPOSITION OF DEMAND IN THE LONG TERM 80 70 60 50 40 30 20 10 Downscaling due to Financial Pressure vs Upgrading 0 Q4-2007 Q2-2008 Q4-2008 Q2-2009 Q4-2009 100 80 60 40 20 0 Percentage of total sellers downscaling due to financial pressure Percentage of sellers selling in order to upgrade Percentage of Suburban Buyers by Race Group 57.0 56.8 55.8 23.0 24.0 25.3 50.0 50.3 30.0 29.5 8.0 7.8 7.5 7.8 7.3 12.0 11.5 11.5 12.3 13.0 2005 2006 2007 2008 2009 Indian/Asian Buyers Coloured Buyers Black Buyers White Buyers 0 Cumulative Real Disposable Income Growth By Race Group - 1999-2008 Black White Coloured Asian Black White Coloured Asian 24 20 16 12 8 4 Percentage of total sellers selling in order to emigrate Not surprisingly, the racial composition of buying in the suburban markets (which largely make up the survey sample) has changed gradually over time. In 2005, the socalled white population group comprised an estimated 57 of total buyers. This had shrunk to 50.3 of total buyers by 2009, while the so-called black population group s percentage rose significantly from 23 to 29.5 (slightly down on 2008) over the same period. The two smaller groups, the Coloured and Asian population groups by comparison saw their percentages not shifting by any significant amount. The steady growth of Black Population Group demand in the formerly white suburban markets is driven by relatively strong disposable income growth when compared to the other 3 population groups, off the lowest base. Globalinsight data estimates are that, for the 10 years from 1999 to 2008, cumulative real disposable income growth for the Black Population Group was 70.5. The better-off Coloured and Asian groups showed growth nearer to 50, while the wealthiest (on a per capita basis) White Population group recorded estimated growth of 40.7. These relative income performances between the 4 groups correspond well to the relative residential buying performances in the transforming suburban markets.

-10 Number of Persons 40 30 20 10 Years Old 0 5 4 3 2 1 65+ 60-64 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 15-19 10-14 05-09 00-04 14.0 Population vs Number of Households 36.9-3.0 5.5 12.3 22.6 22.8 9.8 11.8 30.2 Black White Coloured Asian Total Cumulative Population Growth - 1999-2008 - By Race Group Cumulative Number of Households' Growth - 1999-2008 - By Race Group 4.5 3.8 Average size of household 2.9 2.7 4.7 4.3 4.3 4.1 3.7 3.7 Black White Coloured Asian Total Average household size - 1998 - By Race Group Average household size - 2008 - By Race Group Population by Age Cohorts 0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 2008 1996 The relative disposable income growth rates of the various groups have much to do with government policies aimed at transforming the labour market. In turn, these income growth rates have a key influence in the discrepancy between growth in population versus growth in the number of households, a further driver of housing demand. If one examines the cumulative growth in population of the Black group, it amounted to an estimated 14 over the 10 years from 1999 to 2008. Simultaneously, the number of Black households grew by 36.9. This is not wholly but partly due to new households being established at an earlier age due to an increasing number of labour market entrants having the financial means to do so. Splitting of established households and declining fertility rates combine to reduce the average size of household over time in all 4 population groups. These demographic changes, along with affordability issues which will be discussed in a subsequent section, lead to an increasing need for a greater quantity of smaller average sized residential units over time. Finally, on the issue of changing demographics, it is estimated that South Africa is in the early stages of the ageing population trend. The age cohort 0-4 years old is less than the cohorts just above it (2008 estimates). The 20-29 year old age cohorts grew by 17.2 over the 10 years 1999-2008, while by comparison the 65+ age group grew by a far more rapid 28 over the period. We as a country typically focus a lot on the shortage of housing stock in the affordable segment for first time buyers. But where is the housing shortage the most acute, for entrants or retirees??? And how will this change in the next decade or two? Note: Income and demographic data sources in this section are from IHSGlobalinsight

5. THE CHANGING NATURE OF AFFORDABILITY CONTINUES TO MILITATE IN FAVOUR OF SMALLER-SIZED HOMES TRADITIONAL MEASURES OF AFFORDABILITY SUGGEST THAT THE ISSUE OF IN-AFFORDABILITY HAS DIMINISHED SIGNIFICANTLY IN IMPORTANCE, In recent years, public enemy number 1 for the Affordability residential property market has been seen as the 80 relatively high price of residential properties at a time 70 60 50 when, firstly, interest rates were rising from 2006 to 2008, and then the arrival of recession exerted extreme pressure on disposable income. Estate agents surveyed no longer see this traditional affordability issue (price 40 relative to income) as such a big issue. By the 4 th 30 20 10 Q1-2004 Q1-2005 Q1-2006 Q1-2007 Q1-2008 Q1-2009 quarter, the percentage of agents that believed that income levels were far behind house prices was 46. This was slightly up on the previous quarter, but one must allow for data volatility in this series. More Percentage of respondents stating that buyer income levels have got far behind price levels Smoothed importantly, the percentage remained well-down from the near 70 at the start of last year. AND ALTHOUGH DEBT-AFFORDABILITY IS STILL A BIG ISSUE FOR THE HOUSING MARKET, IT HAS STARTED A MULTI-YEAR IMPROVING TREND TOO. BUT. Arguably more troublesome than the price of homes is the cost of servicing the household debt burden. This cost has declined somewhat, almost solely as a result of last year s substantial 500 basis points worth of interest rate cuts, and 80 70 60 50 40 16 14 12 10 8 6 4 Household Debt to Disposable Income Ratio vs Interest Rates 1990 1993 1996 1999 2002 2005 2008 2011 Household debt-to-disposable income ratio (Left Axis) Household Debt Servicing Costs vs Insolvencies 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Household debt-service ratio (Left Axis) Insolvencies year-on-year change Forecast Forecast 25 23 21 19 17 15 13 11 9 7 5 Prime Rate 120 100 80 60 40 20 0-20 -40-60 almost no thanks to any decline in the debt-to-disposable income ratio. Total outstanding household sector credit showed a mere 2.2 year-on-year rate of growth in the 3 rd quarter of 2009, and looks set to go into negative growth territory in 2010, as the household sector deleveraging drive continues. The de-leveraging drive, however, has been severely delayed by depth of the recession in 2008/9. This caused severe pressure on disposable income growth, which in nominal terms slumped to 1.8 year-on-year, all the way from 13.6 just a year prior, allowing only a marginal decline in the debt-to-disposable income ratio from a peak of 83.4 at the beginning of 2008 to 79 by the 3 rd quarter of last year. This means that the debt-service ratio (the cost of servicing the household sector debt-burden, including interest + capital, expressed as a percentage of disposable income), at 12.9 in the 3 rd quarter of 2009, was still at a level near to some of the past 1980s and 90s peaks, despite rate cuts having lowered it from an estimated all-time high of 15.9 early in 2008. The net result of this is probably summed up in various bad debt statistics, i.e. there has indeed been some improvement in payment arrears, insolvencies etc, but the level of bad debt is still painfully high, and probably will be for some time. The expectation is that the de-leveraging process will continue slowly but surely for the next few years, but that it will be a slow process as usual, only putting the household sector in a position to grow its new borrowing strongly only in the next rate cutting cycle, assuming that this would be somewhere around 2012/13.

Contributing to this de-leveraging trend in the coming years is the expectation that households will continue new borrowing at a far more cautious rate (and banks would lend more cautiously) than a few years ago and, with positive economic growth returning from late in 2009, we should see real disposable income growth also coming out of negative territory by early-2010 to speed up the process a little...the AFFORDABILITY ISSUE ISN T GOING AWAY. THERE S THE BIG ISSUE OF HOUSEHOLD OPERATING AFFORDABILITY However, after painting an improving picture for the two main affordability issues (according to past thinking), the modern South African housing affordability issue increasingly goes further than the cost of servicing debt and buying a house, to matters relating to the costs related to operating a house. There has been much speculation regarding what Eskom s ultimate tariff increases will be, and we may get more clarity in February. But, whatever next month s outcome, utility and municipal rates cost increases in this decade look set to be very significant. CPI numbers already showed electricity tariff increases running at +23.4 year-on-year by December 2009, and although the CPI for water and other services related to housing (which includes council rates) was running at a lower 9.4, the state of water and sewage supply infrastructure suggest that may be a lot more cost increases to come. The recent recession, and its negative impact on government tax revenue, thus driving up government s borrowing requirement, makes it Housing Related Consumer Price Inflation unlikely that we ll see any move to fund more parastatal infrastructure 23 investment off budget. Nor does it appear realistic to expect any significant 18 personal or transfer duty tax relief in this year s budget. 13 Rather, there is a distinct possibility of significant 8 municipal rates increases in the near term to compensate for their 3 revenue shortfalls, accompanying sharp utility Overall CPI CPI - Housing Actual housing Owner occupied Home Water and other Electricity and -2 tariff increases to finance and Utilities rentals housing rentals Maitenance and services other fuels Repairs infrastructure upgrades. These property-related rates and tariffs increases have a number of potential impact points for homeowners as well as some of their service providers. Firstly, the obvious way of countering home operating cost increases is to buy a smaller home on a smaller stand, with less electricity and water-consuming luxuries such as a large garden, swimming pool and domestic workers quarters. Secondly, and something that goes hand in hand with buying a smaller and more manageable home, is to jettison certain services such as domestic home and garden staff. This provides significant policy challenges to government, as the domestic worker sector has been an important employer of less skilled people. Declining average size of stand and of home, and resultant diminishing use of domestic workers by the average middle class suburbanite, has arguably been a long term gradual trend taking place for a few decades. This has been due to increasing land scarcity around major metros, an ongoing trend. But adding sharp rapid increases in services costs to the mix can speed up the trend in increasing demand for smaller properties relative to big ones. In the short term, it is tough for the household sector to adapt, as it is not possible to rapidly change the composition of housing stock. Many home owners bought homes some years ago when costs relating to home operation were relatively cheap. Adjustment is a long term process, and there could well be insufficient supply of smaller-sized units to facilitate a rapid adjustment. We accept that infrastructure investment demands along with environmental issues may make more costly water and electricity a necessary evil in years to come. In addition, somebody will be required to pay for a comprehensive public transport system, one of the further big issues that will be in the headlines during this decade, and densification of living will probably be necessary along transport corridors in order to provide the mass demand for such services. This may necessitate government financial/tax incentives for densification in certain areas. Year-on-year change

It must be appreciated, however, that when property is involved, adapting to major cost changes such as the above is a very slow and costly process. One would hope, therefore, that sanity would prevail and that the up-scaling of tariffs, or changes in behavioural incentives, would be phased in more gradually, allowing the housing market, as well as the domestic worker labour market, and importantly the urban planners, time to adapt gradually. Periodic reports regarding the state of Eskom and local government suggest that there is major room for cost saving from within through improved management and efficiency. These are the new affordability issues set to be a key focus in the new decade, and we believe that this will lead to returns on smaller-sized residential units outperforming the larger ones during the current decade, as households increasingly try to adapt to steadily rising home operating costs. The CPI for housing shows recent rental inflation exceeding that of townhouses, which in turn exceeds the rental inflation on houses. This is believed to be the result of recent income and affordability pressures. Although the affordability issue is changing in nature, it is expected to amount to more of the same, i.e. a trend towards densification in smaller-sized units on smaller sized stands, with less luxuries such as domestic workers quarters and swimming pools. This long term trend, however, may be sped up. The following section will CPI - Housing Rental Inflation show graphs compiled from FNB valuations data, 8 indicating that the cutback process has indeed already been in play for a 7 few decades. The focus, however, was traditionally 6 more on stand size reduction along with servants quarters and 5 swimming pool reductions, but less on building size 4 reduction. During the current decade we expect to see a far more 3 significant reduction in average size of residential 2 building too. Year-on-year change Actual housing rentals Houses Townhouses Flats Are the urban planners and city councils ready for steady densification? Are new public open spaces being created to compensate for a lack of private open space in future? We ve mentioned proximity to transport infrastructure and services, as well as to business nodes, as being a stronger driver of property values in future. Proximity to schools and other important services has also become significant in recent years as traffic congestion increasingly restricts mobility. But we haven t yet mentioned the possible premium that will be paid for properties close to wellmaintained public parklands. Challenging times ahead for SA s cities, and changing times in terms of the way we think about property performance drivers.

THE LONG TERM AFORDABILITY DRIVE AND THE CHANGING CHARACTERISTICS OF RESIDENTIAL PROPERTY Average Freehold Stand Size According To Year In Which The Property Was Built Square Metres 200 180 160 140 120 100 Percentage of Full title Homes with Swimming Pools according to year in which home was built 50 40 30 20 10 0 1100 900 700 500 300 100 28 28 1950-1954 Average Size Residential Building by Age 1950-1954 1955-1959 1955-1959 1960-1964 33 35 1960-1964 1965-1969 1965-1969 1970-1974 44 43 41 1970-1974 1975-1979 1975-1979 1980-1984 1980-1984 1985-1989 32 1985-1989 1990-1994 26 1990-1994 1950-1955- 1960-1965- 1970-1975- 1980-1985- 1990-1954 1959 1964 1969 1974 1979 1984 1989 1994 Average Freehold Property Stand Size 1995-1999 1995-1999 Average Residential Building Size by Building Date (square metres) Percentage of homes with Servants Quarters according to year in which home was built 60 50 40 30 20 10 0 1950-1954 1955-1959 1960-1964 1965-1969 1970-1974 1975-1979 1980-1984 1985-1989 1990-1994 22 24 17 1995-1999 1995-1999 FNB PROPERTY PRO 2000-2005- 2004 2010 FNB PROPERTY PRO 2000-2004 FNB PROPERTY PRO 2000-2004 FNB PROPERTY PRO 2000-2004 Percentage of full title with domestic workers' quarters ( of total full title) Sectional title with domestic workers' quarters ( of total sectional title) 2005-2009 2005-2010 2005-2009 According to properties valued by FNB Valuers over the past 10 years, the average stand size was at its largest (1067 square metres) for the group of freehold homes built in the years 1970-1974. Thereafter, we have seen a steadily declining trend, and homes that were built in the past 5 years averaged a stand size of only 586 square metres. The long term affordability drive appeared to take its toll on average residential building size at a later stage, more towards the late-1980s. Average building size averaged near to 200 square metres all the way up to those buildings built in the 1980 to 1984 period. Thereafter, though, we see a noticeable drop to as low as 148 square metres in the 1995 to 1999 period, the era of extreme interest rate shocks. The 2000-2004 era s buildings reflect better economic times and lower interest rates than the 90s, with average building size recovering somewhat to 174 square metres. A drop back to 160 square metres in the 2005-2009 period reflects the more recent period of economic strain, causing the affordability drive to resume once more, and this is likely to continue in the current decade The long term affordability drive has also meant a gradual cut-back on luxuries. The Swimming Pool Era appears to have been the 1970s, with 44 of full title homes that were built from 1970 to 1974 having swimming pools. Similar to the trends in average stand size, we see a steadily declining percentage of homes with swimming pools in more modern homes, and only 17 of those full title homes built in the past 5 years possessed this luxury. Finally, we demonstrate the downward trend in homes built with so-called servants or domestic workers quarters. South Africa s previous political systems encouraged migrant labour, and thus arguably live-in workers. This was also a more affordable practice in decades past. The start of the trend of decline in homes built with workers quarters is thus probably influenced not only by property affordability matters. It is probably also driven by political change leading to greater freedom of movement for this category of labour, the cost of the labour itself, as well as the changing features of a modernising world, which include services and machinery to partly replace many of the functions of a domestic worker. The net result? Whereas 57 of full title homes built in 1955-1959 had live-in domestic servants quarters (arguably the height of Apartheid and thus restrictions on movements of these workers), only 13 of full title homes valued, that were built over the past 5 years, possess servants quarters. A far lesser 1 of sectional title homes built in the last 5 years possessed this feature.

6.. CONCLUSION The 4 th quarter 2009 FNB Residential Property Barometer survey of estate agents continues to point towards residential market improvement. Demand is up further, albeit only marginally from quarter-to-quarter, but still very significantly on a year-on-year growth basis, and average time on the market is significantly down. Financial stress-related selling is also down, although it is safe to say that it is still painfully high. However, despite growth continuing, the year-on-year rate of growth in the demand activity rating did decline from the previous quarter s growth, which may be an early sign that a plateau in demand will be reached later in 2010 as the interest rate cutting stimulus wears off. The Barometer survey pointed to a slight decline in the percentage of so-called Black buyers buying suburban property, compared with 2008, but this was not significant, and the longer term trend still shows a steady rise in the Black population group s importance in the suburbs. Finally, the survey indicates that, these days, far less agents believe that income levels are far behind home price levels than was previously the case, i.e. they believe that the traditional affordability measure has improved. Our own traditional affordability measures also point towards this. However, we do not believe that the affordability issue has diminished in importance, but merely that it has changed in nature. While the average price/average income ratio has improved, and the cost of servicing debt has also declined somewhat due to rate cuts, the new affordability issue now relates to the costs involved in owning and running a home. The most glaring example currently is Eskom tariff hikes, but don t discount the probability of water, sewage and municipal rates showing steady increases in coming years, as local government s strive to fund shortfalls and other non-electricity infrastructure investment is also required. These rising costs are in favour of smallersized homes and stands with less luxuries built in, while the mounting urban transport and space pressures heighten the importance of location. Indeed, affordability looks set to be a key housing-related theme in the new decade, but in a different form.