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Category:
Insurance
News /
Investments /
First National Bank
/ January 2008
Residential Property in 2008
Into 2008, and as yet little sign of the 3-year+ broad slowdown in
the residential property market coming to an end.
As
things got worse in 2007, so the talk regarding possible house price
declines, rising bad debt in the housing market, further upside
risks to interest rates and prospects for a slowing economy, and the
negative impact of the National Credit Act, seemed to escalate.
Understandably, therefore, many property owners are concerned about
where it’s all going to end. Human beings are often prone to doing
their mental forecasting by extrapolating a recent trend in a
straight line into the future. Fortunately, real life doesn’t work
in this manner. Rather, cycles are the order of the day, and my view
remains that 2008 is the year in which the cycle will bottom out and
begin to turn for the better.
But
let’s consider the risk of a crash in residential property. Well,
firstly, it may be comforting to know that residential property
crashes are not common. In fact, in over 40 years since the
mid-1960s there has only been one, and that was in the mid-1980s.
Already, therefore, this would suggest that the chances are slim.
According to figures supplied by Absa, one sees that since the
early-1970s it was only once in 1984/85 that SA experienced a
nominal house price decline. That was at the end of a major slump
from a price inflation level in excess of 40% in 1981 to deflation
of -9% at a stage in 1985.
In
real terms (deflating the house price index using the CPI), however,
price deflation is far more common. We saw a significant real house
price decline in the latter half of the 1970s just prior to the
gold-boom-drive housing boom, the slide of 84/85, and further
gradual real decline over much of the 1990s to a low in 1997.
Nevertheless, only the mid-1980s slump could possibly be crash, so
it is worthwhile considering its causes.
The
1970s through to the early-1990s was a time of stagnating long term
real economic growth, as the country’s political situation worsened
and isolation and boycotts started to bite, not to mention all sorts
of structural rigidities created by restrictive Apartheid
legislation at the time. Making matters worse was the onset of
commodity price slump from the early-1980s.
If
one were to calculate the sum of national
GDP
for 5-year periods, and then calculate an average annual growth rate
for these 5-year periods, thus cutting out short term growth cycles,
it is clear that from the early-1970s onward the economy
(all-important to the housing market performance) was becoming less
and less supportive to the property market in SA.
Bar
a very short period of spectacular economic growth during the gold
price boom of the early-1980s, of course. Mining was a more key
industry in SA in those days, and it was little surprise, therefore,
to see real GDP growth touch 6.6% in 1980 followed by 5.4% in 1981.
In fact in one particular quarter, year-on-year GDP growth was close
to 8%.
But
it was all set to end in tears. The gold-boom-driven economic boom
was short-lived, proving to be a mere blip in a period of longer
term growth stagnation. The housing market began to slide after
peaking in 1981, as the economy slid into a recession in 1982/83.
The
stay of execution came towards 1984, with the economy experiencing a
brief recovery, but by 1985 the negative forces were far too great.
Not
only did GDP growth slip back into negative territory in 1985, never
to really impress again until the current decade, but extreme
interest rates also contributed to the end of that property party.
From 1981 to 1985, prime rate had risen by 10.5 percentage points
from 11% to 21.5%.
If
that wasn’t enough, individuals’ confidence in the country was not
exactly at all time highs, as we headed nearer to Rubicon Speech
time in the mid-1980s.
The
series of interest rate hikes, coupled with extreme house price
inflation, had driven what is arguably the most important measure of
affordability to its worst levels on record by 1983.
The
ratio I am referring to is the repayment instalment value on a 100%
loan on an average-priced house, expressed as a percentage of
average income (in index form). The graph below illustrates just how
extremely this measure rose in the early-80s boom.
Such levels of “in-affordability” could conceivably be maintained in
a thriving economy, but when stagnation returned following the brief
growth boom, there was only one way for real house prices and that
was down.
And
that was the environment which contributed to SA’s only house price
“crash” in over 40 years.
How
does the current environment compare? Well, glancing back at the
first graph showing real house price levels, you may be tempted to
say that we’re at far more risk now than even at the peak of the
1980s boom, with real house rice levels today far higher. And as at
late last year real house price levels were still rising.
Such an assertion would be too simplistic, however, as
sustainability of house price levels has everything to do with what
the market can afford and not what the price level is.
What the market can afford is determined by the combination of
price, household incomes, interest rates (for many households) and
overall levels of indebtedness.
Going back to the affordability graph, which combines all of the
above factors except overall indebtedness, one will see that the
recent boom has not seen affordability deteriorate nearly as badly
as the early 80s. The index reflecting the average house
price/average income ratio (more relevant for the cash buyer) has
shown a sharp increase since the late-1990s, but is still not back
at early-1980s levels.
Due
the massive interest rate drops from 1998 onward, though, the index
reflecting the ratio of repayment instalment value on a 100% bond on
an average priced house/average income has risen far less extremely,
and at a reading of 181 by the second quarter of last year was still
far lower than the 297 level reached at a stage in 1993.
This containment of the deterioration in affordability is not only
due to interest rates but also in part to strong household
disposable income growth as a result of a strong economic growth
performance in the current decade, growth which has been far more
stable and seemingly sustainable than the boom/bust cycle of the
early-1980s.
The
continuation of this solid growth performance is crucial in staving
off the risks of collapse in the housing market. And risks there
are. Globally, the increasing possibility of a US recession looms
large, while locally it is the spectre of rising interest rates that
threatens growth.
If
we were to go back to interest rates near 20% (or even above), then
indeed significant real house price decline would most probably be
on the cards. This would contribute directly to the affordability
deterioration for credit home buyers, as well as indirectly by
stifling job creation and income growth.
So
one’s view on whether housing is in trouble or not must essentially
be driven by your view on interest rates and economic growth, to
name but the most important 2 macro variables.
Based on our expectations for a fairly moderate growth slowdown in
2008, and, if any, only limited further interest rate hiking, a
deterioration in the local economic environment to such an extent
that it would precipitate SA’s second major housing market crash on
record seems unlikely.
The
long term economic growth graph indicates that SA has been on a
long-term growth acceleration since the early-1990s. This was to be
expected following the end of restrictive Apartheid laws along with
boycotts and sanctions, and the country is still positively
adjusting to the greater degree of economic freedom that this
political change brought about.
So,
when we talk about real economic growth slowdown in 2008, we’re
talking about to around 4% from an estimated 5% last year, hardly a
train smash. Can the US economy’s woes drag SA’s growth far lower
than this?
It
isn’t impossible, but our view is that other regions of the world,
most notably East Asia, are these days better equipped to grow
endogenously, with less dependence on the US, thus providing an
important growth engine whilst the US sorts out its issues.
Therefore, we anticipate a soft landing for both the global economy
and ourselves despite the US and its sub-prime and other challenges.
But
even should the economic and interest rate moves in 2008 prove to be
moderate as we anticipate, you may well ask can households keep head
above water given their high levels of indebtedness?
If
one were to emphasise the household debt-to-disposable income ratio
as the key predictor of a looming credit crunch, one may be tempted
to raise the alarm bells as this ratio heads towards 80%, now by far
the highest ever.
But
more important is the debt-service ratio, i.e. the debt servicing
cost of the total household sector debt burden (interest +
capital)/household disposable income. This ratio had risen to 10.4%
by Q3 2007. The rise signifies greater stress for the household
sector mounting, but by historic cyclical increases it would not
appear out of kilter.
The
previous 3 big cyclical peaks saw debt service ratios of around 12%
(ignoring the 14% blip in 1998 and the small rise in the abnormally
good 2002 cycle).
So
deterioration yes, but crisis no ... based of course upon our
moderate macroeconomic assumptions.
What then do the bad debt figures for banks show to date? Once
again, a fairly moderate situation. DI500s unfortunately only go
back as far as 2001. Special mention mortgage loan accounts
(accounts 1-2 months in arrears) rose through 2006/07 to near 3% of
the total mortgage book for SA’s banks, similar levels to the peak
of the 2002/03 cyclical deterioration (the abnormally good cycle).
Sub-standard loans (in arrears by 3-5 months) have risen to 1.5% of
the total book, doubtful loans (in arrears by 6-12 months) sit at
0.6%, and losses (more than 12 months in arrears) measured 0.9% of
the total book as at November 2007.
Some alarmists may want to emphasise that losses have risen by over
60% since end-2006, and this is true. But off a low base that growth
figure is largely insignificant, and of course the total book has
grown by near 30%, too, since then.
Therefore, while deteriorating, and I expect further deterioration
in credit quality during the first half of 2008, these ratios would
hardly point to a crisis situation in which a major portion of
households would be having houses repossessed.
Therefore, at current interest rate and economic growth levels, the
key ratios suggest that SA’s residential property market is in far
better shape than was the case in the mid-1980s.
There are no guarantees that things can’t still go pear-shaped,
should the interest rate and economic growth environment turn
dramatically for the worse, and the risks are always there. But
based on our forecasts of a mild growth slowdown to 4% in 2008, and
interest rates going into a sideways trend very soon, disaster
should be avoided.
Outlook
This doesn’t mean the end of the road for market weakening just yet.
I believe we should prepare ourselves for a dip into single-digit
year-on-year house price inflation within the next few months, and
it is conceivable that house price inflation could dip below a
resurgent CPI inflation rate briefly in the near future, indicating
some real house price decline.
But
later in 2008, I remain of the view that we will see the turning
point in the market, and a resumption of real house price inflation
to even higher levels. As soon as interest rates level out, we can
expect to see some recovery in growth in new mortgage loans granted
(which showed negative growth in the third quarter of 2007), a good
indicator of residential demand.
This is anticipated during the second quarter. This event normally
coincides with an upturn in month-on-month house price inflation,
and with a considerable lag a turn in year-on-year house price
inflation.
This time around (compared to the 1980s), I expect the economy to
hold up far better in the long term, thus providing little chance
for a slide in the affordability ratios al la mid-1980s.
Rather, the affordability issue will continue to be addressed by a
move towards smaller units on smaller stands and, unfortunately, the
end of the spacious lifestyle that many middle class South Africans
have come to accept as the norm.
Source: ITInews – Insurance
Times and Investments Online
www.itinews.co.za
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