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Did the property bubble ever burst?

27 Nov 2014

The past ten years in the South African residential property sector have been a "rollercoaster ride".

Loos doesn't believe that the bubble ever completely burst, or that the residential market has completed its post-boom “downward price correction”. He explains that current real house price levels are still relatively high by historic standards despite some correction around 2008/9, levels that still largely seems to reflect that 5% plus growth economy that the market had at the height of the property boom.

This is the view of FNB property strategist John Loos speaking at FNB’s 10 Years of Property Barometer briefing, who noted that when FNB’s Property Barometer was launched in November 2004, the residential property market was arguably at its peak. At 35 percent, average house price inflation was fast approaching its year-on-year peak, with demand far outstripping supply.

Ultimately, Loos says, you could call it a “bubble”, or a major “market overshoot”, but it wasn’t purely about speculative activity, despite what some think. The property boom of the last decade was kick-started by rational economic drivers. Economic growth accelerated when democracy arrived in South Africa in 1994 and the country emerged from international economic isolation. Then, the late-1990s brought a sharp drop in interest rates, as SA shifted to Official CPI Inflation targeting, and abandoned the use of interest rates to influence the value of the rand exchange rate.

Cheaper credit helped to drive strong residential demand, which was key in helping house price growth to accelerate rates far in excess of prevailing interest rate percentages. Speculators were able to borrow money to finance property purchases with the aim of making a quick capital gain before selling the property for a major profit.

With the property boom grabbing the media headlines at the time, a buy-to-let buying spree also started up, while widespread first-time “buyer panic” driving demand higher. Buyer panic is seen in times of rapid house price inflation, when aspirant first-time buyers believe that if they don’t buy a property immediately they won’t be able to afford it in future.

The result of the combined factors, first-time buyer panic, strong levels of secondproperty buying, and high levels of speculative activity, resulted in a major market overshoot peaking in 2007. This market overshoot created a secondary problem, as the residential and consumer spending booms had driven up household indebtedness, leaving households highly vulnerable to external economic shocks.

Then the global economic crisis occurred, which included the collapse of the financial services firm, Lehman Brothers accompanied by a massive 2008 oil price inflation shock, as well as a global price inflation spike. The oil shock sent the world and South Africa into a recession. This recession alongside the food price surge, sent South Africa’s CPI inflation rate soaring.

This surge ate into household disposable incomes, and given the official inflation target also meant that prime rate would rise from a low of 10.5% as at mid-2006 to 15.5% by mid-2008. The now highly-indebted Household Sector was far more vulnerable to rate hiking by 2008, and the “house of cards” came tumbling down.

The rise in distress in the banks’ mortgage related loan books was severe, as was the level of proactive selling of homes in order to downscale due to financial pressure, which was estimated at an extreme 34 per cent of total home selling in 2009, according to the FNB Estate Agent Survey.

Home prices fell and the FNB House Price Index showed a -9.4% average house price decline from February 2008 to May 2009. In real terms, when adjusted for CPI inflation, this correction becomes even more significant, around -21.7 per cent around that time. With resistance of sellers towards dropping their asking price, the average estimated time that homes remained on the market prior to sale spun out from five weeks and five days early in 2005 to above 20 weeks by mid-2008.

Crisis led to a “golden era” for home loans

The 2008/9 crisis, perhaps ironically, ushered in what has become something of a “golden era” for the home loans division. The South African Reserve Bank (SARB), and many central banks across the world, brought rapid relief, reducing interest rates sharply to bring the economy out of recession, This greatly reduced the cost of servicing the households’ debt burden and also helped to reduce the level of arrears and non-performing loans, but the “distress” on the mortgage book had also kick-started a healthy response by banks in terms of collections, home loan pricing and credit appetite. 

Banks have since adjusted their pricing to more realistic levels so as to better reflect the risk involved in mortgage lending, as well as their risk appetites.

But did the bubble ever burst?

But Loos doesn’t believe that the bubble ever completely burst, or that the residential market has completed its post-boom “downward price correction”. He explains that current real house price levels are still relatively high by historic standards despite some correction around 2008/9, levels that still largely seems to reflect that 5% plus growth economy that the market had at the height of the property boom.

However, we have been a lowly 1.9% per annum growth economy over the past five years. Looking at the economic growth “super cycle”, which refers to the longer term multi-decade cycle and ignores short run fluctuations, there are few major positive structural changes in the offing that could boost economic growth considerably in the foreseeable future.

South Africa has entered a period of heightened social and political tensions. This manifests in significantly higher levels of disruptive strike action and service delivery protest. Loos believes that this is the start of the gradual move towards the next major political realignment, and that this is likely to be a turbulent process.

The country’s inability to meaningfully raise its productive capacity is contributing to a wide current account deficit on the balance of payments, and factors such as these contribute to ratings downgrades, heightened investor jitters, and pressure on the rand.

Loos still expects 2015 to bring mildly stronger house price growth than recent month’s year-on-year house price growth, with significant supply constraints still supporting house price growth until higher levels of building activity ultimately kick in.

But he believes it is unlikely that the property market can escape negative economic events indefinitely. Loos expects that, looking further ahead, the next decade will be one in which the housing market experiences gradual broad downward correction in real prices towards levels more reflective of a weak economy. This means that house prices could still inflate, but at slower rates than consumer price inflation over much of the period.

However, he expects the correction to be gradual, and that the likelihood of a sharp shock to the property market is significantly less today than back in 2008. This, he believes is due to significant global investment in energy production capacity, notably US shale gas exploitation, lowering the risk of another 2008-style oil price shock. Domestically, the Household Sector has lowered its vulnerability too, with the debt-to-disposable income ratio at a lower level around 73%, from a peak of 83% back in 2009.

While he supports the CPI inflation targeting regime, he would urge the SARB to keep an eye on household indebtedness, and to set interest rates at levels which encourage further decline in the debt-to-disposable income ratio, as well as at a level appropriate in order to prevent the housing market from becoming “over-heated” on such a grand scale again.

Change the only certainty over the next 10 years

While Loos doesn’t expect major booms or sharp crashes in the next 10 years, he believes the property sector will remain an exciting place to be, with the greater focus on urban planning issues.

Urbanisation has contributed to rising urban land scarcity since the late-1970s. As a result there has been densification and worsening transport congestion. The big challenge now is to redesign our cities, and Loos believes it is essential to bring more of the economy and job creation to the largely “dormitory town” former Black Townships. By “dormitory town”, Loos is referring to areas where people largely only live, but commute to areas elsewhere to work because of a lack of economic activity and employment in those areas.

In addition, it will be crucial to link these “Township” areas to the “Suburbs” and existing business nodes with state-of-the-art public transport corridors. Densification along public transport corridors is required to create the demand to make public transport more viable, and restricting densification and providing open public spaces and amenities away from the high density corridors is as crucial. Also implied in such a strategy will be restricting the growth of private transport. And, of course, the green drive will gather momentum, pushing us towards less use of private transport and greater energy efficiency.

Key additional challenges will be around developing affordable housing solutions for the remaining households not yet housed in formal housing, a major challenge given an unemployment rate at around 25%. This speaks yet again to a major change in housing design, and again comes down to intelligent densification to more efficiently utilise scarce urban land.

But Loos believes that residential land reform will still be the country’s big land reform success story over the next 10 years. It is estimated that great progress has been made in increasing the number of households housed in formal homes, from 68.7% of total households in 1996 to 76.6% by 2012. And the FNB Estate Agent Survey estimates that near 50% of suburban home buyers are from previously-disadvantaged race groups.

Finally, A further key property theme will be retirement property, given that the strongest population growth is now occurring in the 50 plus age group in SA.

In short, Loos says, the next 10 years will be a time for the clever investor. In a time of mediocre economic growth and major urban change, the old adage of “location location location”, along with the modern adage of “design”, and dramatically improved utilisation of space, will be more crucial than ever.

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