Property price drop may not be as big as feared

http://www.persfin.co.za/index.php?fSectionId=709&fArticleId=4443202

Residential property prices could continue to fall for two years. We report on how much pain property owners, sellers and buyers can expect to take, as well as how to make the best of the downturn.
June 7, 2008

By Neesa Moodley-isaacs

Property economists have painted a rather gloomy picture of the prospects for the residential property market in the years ahead, although the situation is not as dire as predicted by one major estate agency earlier this week.

John Loos, First National Bank's property strategist, says the list of negative influences on the residential property market is long, and includes rising interest rates, increasing inflation, a slowing economy, the impact of the National Credit Act, the electricity crisis, low income yields and the recent xenophobic violence.

Loos has projected a 21-percent decline in the value of new mortgage loans and re-advances granted for this year and says we are entering a period of house price deflation.

"South Africa's new mortgage market grew in value by almost 900 percent from 1999 to 2007 and house price inflation over the past decade was a few hundred percent," Loos says.

He says this means the current downturn in the property market is not the end of the world. However, because the list of negative factors affecting the market is longer than he had previously anticipated, Loos says the magnitude of the downturn would be more extreme than previously forecast.

Lew Geffen, the chairman of Lew Geffen Sotheby's International Realty, was quoted earlier this week as saying that property prices could fall by up to 40 percent from last year's highs.

However, property economist Erwin Rode, of Rode & Associates, says estate agents tend to equate market activity with changes in house prices. Although the number of house sales could drop by as much as 40 percent in the year ahead, this does not automatically mean that house prices will fall by the same percentage," Rode says.

"I expect that by next year or the year thereafter, residential property prices will have fallen by about 10 percent from current prices," he says. According to Rode, the bleak outlook is not likely to disappear overnight and property prices could hit rock bottom by 2010.

Geffen was quoted in daily newspapers this week as saying that his prediction of a 40-percent drop in house prices is borne out by the fact that banks are only offering mortgages where clients put down a five-percent to 25-percent deposit.

He says Absa, for example, is only providing 100-percent home loans for properties valued up to R800 000. For properties priced from R800 000 to R2.7 million, Absa will provide a 95-percent loan and, if the property is priced between R2.7 million and R4 million, the bank is only providing a 90-percent loan.

No straight line
However, Jacques du Toit, Absa's senior property analyst, shares a similar outlook to Rode's.

"You cannot draw a straight line between the deposit banks are asking mortgage owners to pay and a possible drop in house prices. There is much more to the calculation and it's simply not that straight- forward," he says.

Du Toit says he does not foresee a 40-percent drop in prices across the board in the next year.

"While we do expect the downward trend in house prices to continue, it definitely won't be to the extent stated [by estate agents]," he says. Du Toit says he expects the downward trend to bottom out late in 2009, with a slight sideways movement before the property market recovers very gradually from 2010.

Du Toit says the factors that have to be considered when looking at the property market include inflation and interest rates.

"Inflation is likely to remain quite high for some time and so will interest rates. The housing market is interest rate-sensitive, and people are likely to sell despite the fact that they are going to get lower prices than they would have a year ago. This applies particularly to people who bought property as speculators with the intention of selling later at a high profit," Du Toit says.

Mortgage bond repayments have already increased 32 percent on the back of nine rate increases since June 2006. According to Du Toit, overdue mortgage loans as a percentage of total mortgage loans increased from a low of one percent at the end of 2006 to 1.5 percent at the end of 2007, and probably increased again this year.

However, they are still well below the average of 6.6 percent recorded in 1999 after interest rates went as high as 25.5 percent in 1998.

Sizwe Nxedlana, the property economist at Standard Bank, says inflation is expected to remain above the Reserve Bank's target band of three to six percent for the next three years.

Nxedlana says further interest rate increases will mean that fewer people will pass the affordability test for new mortgage bonds, fewer mortgages will be granted and registered, and growth in house prices will be less likely.

Further stagnation
Rode says there is usually a lag of nine months between a change in interest rates and a change in house prices. "If you take into account that we are expecting two more interest rate hikes and then are looking at an effect on house prices nine months after the last interest rate hike, we are looking at an extended period of stagnation, if not a decline, in prices," he says.

Many sellers are still expecting to obtain unrealistic prices for their homes, based on the high price growth of the past few years. Rode says sellers need to drop their asking prices to more realistic levels.

"When you are making a buy-or- sell decision, you should never consider the historic cost of the house, as this is irrelevant.

"For example, if you bought a house for R2 million six months ago, the price you paid then has nothing to do with the price you will get for the same house if you sell it today. People assume they must get a better price than the price they paid, but that's not how the market works," Rode says.


How you can survive the property blues
High interest rates and high inflation are here to stay for a while. It is unlikely that we will see a drop in either in the near future, property economist Erwin Rode, of Rode & Associates, says.

If you do not urgently need to sell your property, you should sit out the drop in the market over the next two years at least. This means if you have a strong cash flow, are able to meet your mortgage bond repayments and do not need to sell - for example, to avoid repossession - you should not try to sell your property right now.

If you have bought a property for investment purposes, Rode says, you should put it up for sale and get out of the market as soon as possible.

The residential property market is not likely to be a good investment for the next five years, he says.

Many property owners who took on a mortgage bond of 100 percent or more over the past five years are likely to face a negative equity situation in the next 18 months, Rode says.

Negative equity means you owe more money on your mortgage bond than the actual value of your property. If you have bought a property as your primary residence, this does not necessarily present a huge problem, because all you have to do is ride out the next few years and make sure you are able to meet your mortgage bond repayments as they increase in line with interest rates.

However, you would be well advised not to take out any further loans against your property in the near future, because, should you be forced to sell your home in the next two years, it is unlikely you will obtain a selling price that will cover the entire mortgage amount you owe.

Rode says now is a good time to renovate your home, because small builders are being hit hard. "Small builders are under pressure and looking for work. You will probably get better quality work done on your home now, because small builders are more likely to look after their customers in the current environment," he says.

If you are looking to buy a property, Rode says you should not be in a hurry. You should ideally wait a year or two, because you are likely to pick up a better bargain as the property market gets worse for sellers.

Fixing your home loan interest rate may prove the more costly option for you
You may be thinking about fixing the interest rate on your home loan to avoid dealing with further interest rate hikes and the stress of higher mortgage bond repayments.

However, Mokgatla Madisha, a fixed-income analyst at Investec Asset Management (IAM), cautions that this may be a costly decision. "You could end up paying more in interest than if you were to ride out the [interest rate] cycle," he says.

Although he agrees with property economists that inflation is likely to remain above the Reserve Bank's target band of three to six percent "for a while", Madisha does not think South Africa is facing a situation of ever-increasing inflation and interest rates over the next two years. Instead, he says, inflation is likely to be elevated over the medium term.

"A year from now, interest rates could start to fall, but they are not going to fall very fast, neither are they going to fall very far," he says.

Madisha says fixing your interest rate for two years could mean that you are stuck paying off your mortgage bond at 16 percent in 2010 while inflation could have fallen back to six percent and interest rates could be reduced to 12 percent.

Banks generally offer you the opportunity to fix your interest rate at about half to one percentage point above the prime rate - currently 15 percent - for a period of up to two years. A variable interest rate linked to the prime rate is usually anything between one and two percentage points below prime.

The disadvantage of fixing your interest rate now is illustrated by the following examples:

# Homeowner A, who has a mortgage bond of R1 million and who pays an instalment of R11 715 a month at prime minus two percentage points - that is, 13 percent - decides to ride out the interest rate cycle. If it is assumed that interest rates are raised by one percentage point at each meeting of the Reserve Bank's monetary policy committee in June, August and October, and then stay level until May 2009, the prime rate will be 18 percent by October, and Homeowner A will be repaying R13 912 a month on an interest rate of 16 percent.
# Homeowner B, who also has a mortgage bond of R1 million, chooses to fix his home loan at prime plus one percentage point now, which will result in his monthly repayment increasing to R13 912.

This means Homeowner B will immediately have to cough up every month what Homeowner A will start paying only in October. Over a full year, Homeowner B will be paying about R6 000 more.

Madisha says IAM does not foresee a three-percentage-point hike in interest rates during this year.

"We anticipate a further one to 1.5-percentage-point-rate hike until the cycle peaks, which would mean that the homeowner on a fixed rate is even worse off. He could be stuck for another year at the fixed rate, while those on a floating rate, or a rate linked to the prime rate, could start enjoying the respite of lower interest rates."