House Price Drop May Not Be So Drastic

Price Drop May Not Be So Big

Property economist for FNB, John Loos was recently reported as predicting a 40% drop in house prices by year-end. An article published in Personal Finance refutes these predictions with reports from ABSA’s senior property analyst, Jacques du Toit, who shares a similar outlook as property economist Erwin Rode - while house sales could certainly drop by as much as 40% in the year ahead, this does not mean that house prices will fall by the same percentage.

“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 straightforward,” du Toit says. In fact, he does not foresee a 40% drop in prices across the board by the end of 2008.

“While we do expect the downward trend in house prices to continue, it definitely won’t be to the extent stated [by estate agents],” du Toit insists. He expects the down cycle to bottom out in late 2009, with a slight sideways shift before the property market recovers gradually from 2010.

When it comes to factors that need to be considered in looking at the property market, du Toit highlights 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,” says du Toit.

An increase of 32% has been seen with mortgage bond repayments and this on the back of nine rate increases since June 2006. According to du Toit, the percentage of overdue mortgage loans increased from a low of 1% at the end of 2006 to 1.5% at the end of 2007 and most likely increased again this year. Even so, they are still far beneath the average 6.6% recorded in 1999 after interest rates peaked at 25.5% in 1998.

Standard Bank’s property economist, Sizwe Nxedlana says that inflation is expected to remain above the Reserve Bank’s target band of 3%-6% for the next three years. He adds that further interest rate hikes will result in fewer people passing the affordability test for new mortgage bonds, consequently fewer mortgages will be granted and registered, and a growth in house prices will be less likely.

Erwin Rode explains that there is generally a lag of 9 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,” according to Rode.

Rode says that many sellers are still expecting unrealistic prices for their homes, based on the high price growth experienced in the last few years. He adds that sellers need to drop their 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,” says Rode.

How can you survive the property blues? The fact remains that high interest rates and inflation are here to stay for a while. It is unlikely that a drop in either will be seen in the near future, argues Rode. Thus, if you do not urgently need to sell your property, you should sit out the drop in the market for at least the next two years. In other words, if you have a strong cash flow and can afford your bond repayments, you should not try to sell your property right now.

However, if you have bought property for an investment purpose, Rode suggests that you put it up for sale and get out of the market as soon as possible. He believes that the residential property market is not likely to be a good investment for the next five years. In fact, many homeowners who took on a mortgage bond of 100% or more over the last five years are likely to face a negative equity situation in the next year and a half.

Essentially, a negative equity situation means that you owe more money on your mortgage bond than the actual value of your property. If the property you have bought is your primary residence then this does not necessarily pose a big problem because all you need to do is ride out the next few years and ensure that you meet your mortgage bond repayments, as they increase in line with rising interest rates.

However, Rode advises that you refrain from taking out any further loans against your property in the near future because should you be forced to sell in the next two years, it is not likely that your selling price will cover the entire mortgage amount owed. Rode suggests that now would be a good time to renovate, as small builders are being hit hard. “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,” says Rode.

If you are in the market to buy a property, Rode advises that you wait a year or two, as you are more likely to pick up a bargain as the property market worsens for sellers.

Those who are looking to fix their interest rate on their home loan to avoid dealing with further interest rate hikes and the stress of higher mortgage bond repayments should beware. Mokgatla Madisha, a fixed-income analyst at Investec Asset Management cautions that this could be a costly decision and “you could end up paying more in interest than if you were to ride out the cycle”.

Although in agreement with property economists that inflation is likely to remain above the Reserve Bank’s target band, Madisha does not believe South Africa is facing a situation of ever-increasing inflation and interest rates over the coming years. Instead, he thinks that inflation is more 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 predicts.

Fixing your interest rate for two years could mean that you are stuck paying off a mortgage bond at 16% in 2010 when inflation could have dropped to 6% and interest rates could be reduced to 12%. Banks usually offer you the option to fix your rate at about half to one percentage point above the prime rate (currently 15%) for a period of up to two years. A variable interest rate linked to the prime rate is generally anything between one and two percentage points below prime.

Modisha says that Investec does not foresee a 3% interest rate hike for the rest of the year. “We anticipate a further 1%-1.5% 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,” explains Modisha.

The information in this article is courtesy of Neesa Moodley-Isaacs (“Property price drop may not be as big as feared”, Personal Finance, 7 June 2008).

If you would like to buy or sell property in South Africa, please visit www.sahometraders.co.za.