The slow puncture of property prices has begun

Cape Town – The “slow puncture” of property prices decreasing to levels that better reflect a poorer economy has started, FNB property economist John Loos revealed in Cape Town on Thursday.

“We've had all the structural changes, adjustments in rates and jumps in the energy market,” he told media at the FNB Portside building.  “And now economic growth is pedestrian.

“The abnormal stimulus that kept the party going from 2008 is over,” he said. “The economy is stagnating and price levels need to reflect that better.”

He said that while the residential property market remained solid, growth in the market appeared to be gradually running out of steam.

Loos said that while the time for a more significant “downward correction” in real house prices may be nearing, “one shouldn’t misinterpret this for some kind of rapid crash in home values, because this need not be the case”.

He did caution that “now is not the greatest buying opportunity”.

Slow pace to correct price

“Many housing market corrections take place slowly in real terms,” Loos said, “where often over a number of years one gets slow house price inflation, which by and large remains below the general rate of inflation in the economy as measured by such common measures as Consumer Price Inflation (CPI), or wage inflation.

“This means that, while house values may be rising, in real terms when adjusted for CPI inflation they are declining gradually, thereby in effect bringing about a gradual move to lower real home values.”

Timeframes for real housing market corrections can be particularly long, and Loos reminds us that the previous big downward correction of the 1980s/90s took place over almost 15 years, from 1984 to 1998, creating a very low real house price base off which the country could launch one of its biggest house price growth booms from 1999 to 2007.

Graph: FNB Home Loans

The 1999 to 2007 house price boom explained

The extreme house price boom from 1999 to 2007 had its foundations in two key structural economic changes, Loos said.

Firstly, the political settlement that led to democratic rule in 1994 brought about the end of the country’s economic isolation through disinvestment, boycotts and sanctions.

This meant that South Africa could normalise trade and business ties with the world, export and investment performance improved, and so too did economic growth, employment and household income growth.

Then, in the late-1990s it was announced that the South African Reserve Bank (SARB) would move to an official inflation targeting regime, moving away from its strategy of trying to protect the value of a volatile rand with often extreme interest rate levels.

With CPI inflation having been on the decline from the late-1980s onward, this policy shift meant no further need for the extreme high interest rates of the late-1990s, and the result was what Loos calls a “major once-off downward structural adjustment” in interest rates starting late in 1998.

The interest rate stimulus was massive, with the then lower-indebted household sector able to grow its borrowing rapidly, thus creating a strong surge in demand for what were then very cheap homes.

The strong double-digit house price inflation that followed, combined with low interest rates, created a paradise for speculative activity of which there was said to be a great deal. Many first-time buyers sped up their home purchase out of panic thinking that if they did not, they would no longer be able to afford property in future.

The result was a real house price peak at the end of 2007 that eclipsed anything in the country’s recorded history, said Loos.

Downward correction not nearly completed

Loos said the “downward correction” process that started at the end of 2007 was not nearly completed. “Yes in real terms, as at March 2015, the FNB House Price Index was -17.2% down on December 2007’s real price high,” he said. “However, it is still a massive 68.8% up on January 2001, just before the real big boom time price inflation started.”

Loos believes that current real house price levels still in part reflect that 5%+ annual economic growth phase that we were fortunate to have prior to 2008, as well as perhaps some speculative activity and first-time buyer panic from that boom era.

Abnormal stimulus affected prices

Prices weren’t “fully corrected” since the end of the boom and the short, sharp 2008/9 recession, said Loos.

He said the correction was cut short by an abnormal fiscal and monetary stimulus across much of the globe, as well as domestically where government widened its fiscal deficit and the SARB cut interest rates to multi-decade lows in order to “keep the economic party going”.

Said Loos: “This delayed the full correction.”

Stimulus is finished

But now, Loos said, we have reached the point where the stimulus is running out.

Government has begun to raise taxes more aggressively to narrow the deficit and curb its debt growth, while the SARB believes that it is time to start “normalising” interest rates upwards soon.

The world’s biggest economy, the US, looks set to do the same fairly soon. And on top of the stimulus running out, Loos said that there is little structural economic change happening in SA at present, and often-disruptive social tensions appear to have been rising. All of this means that we appear destined to be perhaps a 1% - 2% growth economy at best, instead of a 5%+ one.

Ultimately, he said that real house prices have to reflect economic weakness and absence of further fiscal and monetary stimulus, as they did through the late 1980s and much of the 1990s, and this probably means lower prices in real terms from the currently high levels.

We had expected one last postponement of the “correction” to come from sharply lower energy prices early this year, and a resultant boost to the economy.

“However, against this we have electricity constraints proving disruptive to the economy, while non-energy commodity prices have also fallen, hampering certain key SA exports and thus economic growth,” he said.

“The result has been what appears to be a disappointing start to 2015 economically, and the pace of residential market strengthening has slowed.”