PROPERTY: Be Skeptical About The House Market
Recent Western Cape Business News
There are many optimists who predict that house prices will start to recover by the end of 2009. Let’s think this one through, says Bellville-based property economist Erwin Rode.
“Recover” needs to be defined, of course. If it means that prices will stop sliding in nominal terms, then this is remotely possible. But nominal prices that stop sliding are not the same as any meaningful rise. To rise significantly, prices have to exceed rises in inflation, which could either be regarded as consumer inflation (as in the CPI) or replacement costs. So how realistic are the medium-term prospects for real growth?
Prices are in real terms still exceedingly high compared to the real peaks of prior cycles, for instance the previous peak in the middle of 1984. These high values are the result of prices having risen much faster than incomes for many years indeed. In fact, since about 2004, house prices in South Africa have been well above their long-term trend line (1966-2008). In our book, that is another way of saying prices have been in a bubble since this date. Such a situation is evidently not sustainable, and the prick of the bubble had to happen sooner or later. The prick is normally a sharp rise in interest rates as the economy runs out of capacity; but this time around it was the world economy that provided the initial wake-up call. Historically, in this country these corrections haven’t been apocalyptic. Rather, what typically happened was that nominal prices would decline by up to 10% initially and, thereafter, real prices would decline for many years until prices are once again in line with incomes and interest rates on mortgage bonds.
But there are additional reasons to be suspicious about a vigorous turnaround in the prices of houses, namely the cost and availability of credit.
First, the cost. 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. Interest rates of prime minus 2% points were common. Now, with sales volumes down and risks higher, banks can no longer afford these tight spreads and are forced to restore margins. As a consequence, prime plus 2% points is now common. Incidentally, and this is of crucial significance, as this ratcheting-up of margins has effectively neutralised the cyclical lowering of interest rates by the Reserve Bank. Put differently, for the man in the street servicing a (new) mortgage bond, interest rates haven’t come down by much.
Not only has the effective cost of credit not come down by much, but banks are now also insisting on deposits of 10-20%. Say good-bye to mortgage bonds of more than 100% of market value. Stories are rife of bank officials who encouraged “liberal” valuations during the boom times so as to ensure more business and higher performance bonuses for themselves. The net effect of this is that we are now sitting with a “lost” generation of first-time home-buyers who must first save for a deposit before buying; thus being unable to buy.
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.
One of the unintended effects of the National Credit Act (NCA) is that it now takes banks much longer, and at greater expense, to call up a mortgage bond, collect debt and write down bad debt. SARS, by the way, does not allow writing down of bad debt without a court order. The s. 129 notice and prescribed procedures opened the door for professional debtors to string out the process by going through debt counselling while still staying on in their houses. An attorney we spoke to, claims there is “chaos” in our courts, with stacks of court applications waiting for judgement and attachment.
It is surely not difficult to imagine that the NCA thus has the effect of making banks more conservative in granting mortgage bonds. The motto seems to be: rather no business than bad business. And who can blame them?
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