House prices face an uphill battle as affordability becomes an issue

Affordability is likely to be the big issue affecting house price growth in the coming year or two. Despite South Africas record economic growth, real wages have been unable to match the massive jump in house prices recorded since 2000. Both Standard Bank and ABSA recently released updates on the property sector.

ABSA reports the average middle-income home to be worth R911, 800. The ABSA survey is "based on the total purchase price of houses in the 80m to 400m size category valued at R2.7 million or less in 2006 (including improvements), in respect of which loan applications were approved by Absa." Standard Bank's median house price is recorded as R580, 000.

These bank surveys are obviously based on slightly different research parameters. But both conclude that consumers continue to pay more for the average house. To cover the monthly bond instalment of R6, 589 on a home costing R580, 000, a family would require a gross income of R20, 000. If the property cost R911, 800, the family would need a combined gross income of R30, 000 to cover the R10, 600 in monthly repayments.

With properties already priced near the top of the affordability line, it makes sense that either house price inflation abates slightly, or wage inflation rises significantly. Governments recent stance at wage negotiations indicates that the latter is rather unlikely...

Income distorts the affordability equation

In February this year we reported some of Rian le Roux's views on the local economy. Le Roux, an economist at Old Mutual Investment Group (OMIGSA), felt that the large increase in domestic credit was partly offset by improvements in household balance sheets.

A balance sheet is a statement of assets and liabilities at a given point in time. It is most commonly associated with the annual financial statements of larger corporations - but is also applied to personal financial situations. Banks often request statements of assets and liabilities when considering credit applications.

To draw up a household balance sheet we simply consider all the assets and debts 'owned' by the household in question. Assets include the value of the primary residence, stock market investments, unit trusts, cash and any other fixed property with realisable value. Debts include balances on home loans, credit cards, hire purchase agreements and any similar arrangements.

Because house prices have been growing steadily, banks have not been too worried about the amount of money they lend to house buyers. The problem is that the issue is no longer one of credit extension - but rather one of repayment. Real household income has not kept pace with house price inflation and this means buyers are now struggling to qualify for and pay back their housing loans.

The National Credit Act could rain on the house price parade

Another threat to the local property market is the National Credit Act. The final part of this Act comes into effect in June this year. Banks are likely to take a tougher stance on extending credit for home loans. One of the key requirements of the Act is that a proper assessment is done of the borrowers ability to repay the loan.

This requirement is not likely to affect the market for primary residences. In this regard similar requirements to what currently prevail are likely. However, it may well have an impact on the market for buy-to-let and other investment property purchases. Banks might take a tougher line on extending more than one home loan to an individual investor. They might also consider whether individual borrowers have signed surety through close corporations And this could have a significant impact on property sales and prices across the residential property spectrum.

Rural properties less affordable

Despite rural properties being cheaper on average than urban properties, they remain less affordable. This is due to the lower income available to purchasers in rural areas. ABSA senior economist, Jacques du Toit, told Fin 24 that the house price-to-income multiple in South Africa's rural areas rose sharply from 4.8 times in 1999 to as high as 10.5 times in 2005. Meanwhile, the urban indicator increased from 2.7 times on average during 1996 to 1999 to 5.2 times in 2005.

Despite the affordability issue, house prices in South Africa appear set for a period of slower growth rather than a collapse. While yields in the residential letting market remain under pressure, there are still opportunities for the astute property investor to attain market beating returns.

Editor's thoughts:
From June 2007 the National Credit Act comes into full force. Parts of the Act require banks to apply stricter lending criteria. Do you think the National Credit Act will have an impact on small property investors in South Africa? Send your comments to [email protected].