Exploding the house price recovery myth

Gareth Stokes, FAnews Online Editor

Will South Africa’s residential property market stage a quick recovery? It’s a question many of the top property economists and commentators have been grappling with for some time. Although house price growth has been in decline for around two years the o

Getting down with definitions

Economists, investors and laypersons interpret economic phrases differently. An economist’s interpretation of the phrase “green shoots of recovery” so often bandied about by the financial media is markedly different from the laypersons. Economists use the phrase to describe barely visible improvements in a data series, while readers generally interpret the phrase as indicative of a significant turnaround. Before we can predict a ‘recovery’ or ‘turnaround’ we have to agree on the meaning of the respective terms. If we move this argument to the property space, then the layperson might shout ‘recovery’ when house prices stop sliding in nominal terms, whereas an economist would prefer a meaningful rise (perhaps even a return to real growth) before using the word.

What qualifies as a “meaningful rise” in house prices? Rode & Associates says that house prices have to outstrip the rises in inflation before we can call a ‘recovery’. The common measure of inflation is consumer inflation (CPI), but building replacement costs will also serve in this regard. Although recent house price indices indicate a slightly improvement in the rate of decline of house prices, we are nowhere near real growth. There are a number of reasons for this.

The house price bubble nobody talks about

The first stumbling block, says Rode & Associates, is that “house prices – in real terms – are still exceedingly high compared to the peaks of prior cycles.” Based on house price data going back to 1966, South African house prices have been “well above their long-term trend line” since 2004. Many housing market commentators seem oblivious to price trends prior to the property boom that spanned 2003 to 2007. But these trends cannot be ignored and lead Rode & Associates to an uncomfortable conclusion – that house “prices have been in a bubble since that date!” The bubble has deflated under the combined impact of high interest rates and a collapsing global economy, but still remains.

A second major obstacle to a significant recovery is that growth in house prices has outstripped income for many years. This trend in affordability makes it more difficult for first time buyers to gain a foothold in the property market. The next major issue is how one can predict a vigorous ‘recovery’ when credit remains scarce and expensive? “During the boom times the banks as mortgagees were in cut-throat competition with one another to lend to the public, chasing volume at the expense of profit margins,” says Rode & Associates. Homeowners revelled in bank loans of 100% (in some cases more) against the underlying asset value and interest rates as competitive as prime less 2.25%. When credit dried up towards the middle of last year the banks simply pulled the carpet out from under the prospective homebuyers’ feet.

“Now, with sales volumes down and risks higher, banks can no longer afford these tight spreads and are forced to restore margins,” says Rode & Associates. Homebuyers were suddenly faced with the prospect of home loan rates of prime plus one or two percent. This short-term hike in bank margins neutralised some of the impact of the 450 basis point interest rate cut experienced since December 2008. Banks have also become more careful where it comes to exposure. The days of ‘cowboy’ valuations and 100% bonds against those valuations are over. Nowadays the assessor is more conservative in valuing a property, while banks are asking almost 20% (on average) by way of deposit. “Thus, the financial meltdown has reintroduced a fundamental rule of banking, namely that the mortgagor must also have a significant financial stake in the bonded property: sound banking practice can only support 100% bonds as a short-term aberration while the prospect of rising house prices continues to outweigh the risk of default.”

Suggestions of a quick recovery are misdirected

The house price market has one final hurdle to overcome. Prospective buyers are screened more aggressively today than during boom times. The National Credit Act requires stringent assessments of the individual’s ability to repay his mortgage bond – and it makes things extremely difficult for the bank to reclaim its property in the event of default. It will take years for the industry to accommodate these regulatory requirements at previous volumes and values.

It will also take years before inflated house prices cool down. “What typically happens is that nominal prices decline by up to 10 percent initially and, thereafter, real prices decline for many years until prices are in line with incomes and interest rates on mortgage bonds,” says Rode & Associates. The cherry on top in today’s scenario is the dire economic pantomime playing out around the globe. Against this backdrop it seems unlikely the ‘recovery’ will be underway by late 2009, early 2010 or even halfway through next year. We expect plenty of property pundits will challenge the assumptions carried in this article. Rode & Associates leaves the ball in their court. Given the arguments presented above, they ask: “Do you still think an ‘upturn’ or ‘recovery’ in house prices is just around the corner?”

Editor’s thoughts: The Rode & Associates’ article puts recent positive comment around prospects for residential house prices in the spotlight. Clearly there are a number of systemic issues that must be addressed before a real ‘recovery’ gets underway. Do you think an ‘upturn’ or ‘recovery’ in house prices is just around the corner? Add your comment below, or send it to gareth@fanews.co.za