We should be sceptical about the house market

There are many optimists who predict that house prices will begin to recover by the end of 2009, but let's think this one through, says an article in the July issue of the monthly Rode Review.

"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 be taken as consumer inflation (as in the CPI) or replacement costs. So how realistic are the medium-term prospects for real growth?

Prices remain exceedingly high in real terms, compared with 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.

Since about 2004, house prices 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 percent initially and, thereafter, real prices would decline for many years until prices were 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 percentage points were common.

Now, with sales volumes down and risks higher, banks can no longer afford these tight spreads. As a consequence, prime plus 2 percent is now common. Of crucial significance is that this ratcheting up of margins has in effect 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 between 10 percent and 20 percent.

Say goodbye to mortgage bonds of more than 100 percent of market value. Stories are rife of bank officials who encouraged "liberal" valuations during the boom times to ensure more business and higher performance bonuses for themselves. The effect is that we are now sitting with a "lost" generation of first-time home-buyers who must save for a deposit before buying, and so are unable to buy.

Thus, the financial meltdown has reintroduced a fundamental rule of banking: that the mortgager must also have a significant financial stake in the bonded property; and sound banking practice can support 100 percent bonds only 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 is more expensive, to call up a mortgage, collect debt and write down bad debt. The SA Revenue Service does not allow the writing down of bad debt without a court order.

The s129 notice and prescribed procedures opened the door for professional debtors to string out the process by going through debt counselling while staying on in their homes. One attorney says there is "chaos" in our courts, with stacks of applications waiting for judgment and attachment.

It is surely not difficult to imagine that the NCA has the effect of making banks more conservative in granting mortgages. The motto seems to be: rather no business than bad business. Who can blame them?

All the above factors haven't even considered the extraordinary world economic prospects and their impact on South Africa.

So, dear reader, do you still think the "upturn" or "recovery" is around the corner?

'The banks' motto seems to be: rather no business than bad business'

Weekend Property Supplement (Saturday Argus)

Posted at 10:12AM Jul 27, 2009 by Editor in Market  |