By Cees Bruggemans
With housing booms coming off the boil, spectacularly imploding in the US, where an average 25% price decline is in progress, but with the glue also undone in formerly overheated hotspots such as Spain, Ireland and UK, there has been growing anxiety about our own housing market.
Are we also in the throes of an implosion?
With house prices no longer racing along at high double digits, as they were for years, rising three-fold or more in value since 2000, going by municipal valuations, at one stage completely eroding the depreciation discount on old as compared to new housing, are we also destined to pay the piper?
House price gains have by now slowed to low single digit, even to the point of standing still. Properties are spending much longer time on the market, nearly no one is any longer getting their initial asking price, and discounts are growing, alarmingly in stressed situations.
Is that the full reach of our housing market adjustment or a mere opening bid?
There are two areas of extreme risk for our property market. The one is internal, the other external. And then there are the support pillars, still making the long run case for property, even overwhelmingly so.
The main internal risk dimension would be political, as has shown up before, most spectacularly in 1960 and 1976. The main moral of those fearful property reactions, however, was that the eventual price recoveries were even more spectacular than the preceding implosions.
But that was only because the assumptions underlying the political perceptions of those key events proved unwarranted in the short-term.
However, could sheer terror get lucky a third time? And is blind trust in the long-term a good rule? It wasn’t in Cuba in 1959 or in North Korea in 1953 or in East Germany in 1945 or in Russia in 1917. Or for that matter in 1948 or in 1913 in South Africa, if you were black.
Then again, some 50-100 years after each of these political upheavals and their social recasting, subsequent market revolutions ultimately have won out, or will probably eventually come. Such is the nature of political experimentation.
So on a 100 year view, even political risk could turn out to be a negotiable form of pessimism.
But does that apply to Africa at large, too? It probably does, with Zim the immediate test case, but Congo and others the ultimate challenges. The only real enemy appears to be underdevelopment, resisting change much more thoroughly than revolutionary ideology. The institutional inertia marking underdevelopment is apparently much more difficult to overcome than the conceptual failings of revolutionary ideology.
It seems much more difficult to get underway from a position of rest, compared to changing direction by learning-through-doing while already underway.
But then Africa is getting lucky one more time on the coattails of Asian catch-up growth, its urbanization and industralisation heavily reliant on commodities.
With other parts of the world becoming exhausted as commodity suppliers, and with global customers wanting strategic diversification, China and America foremost, Africa is well positioned to earn a late windfall, and as late developer overcoming lingering inertia.
But 50-100 year detours can be fatal to a generation or two, so one wants to get the timing right. Exiting Zim in 1975 was an excellent idea, as may be re-entry by 2025.
The risk of political detours isn’t non-negligible. Internal population dynamics in non-homogeneous societies or external economic pressures can provide the trigger. A global devastation as in the 1930s would severely test our institutional fabric and the policy choices we choose to live by.
But these are extreme propositions. On the presumption that South African society will not tear itself apart in the short-term, today being guided by a broad church of political interests, and similarly assuming the world won’t allow itself to be imploded economically or politically any time soon, the number of icebergs remaining appears much reduced.
That leaves external risks, of which there are many variants, some fanciful with low probabilities, but others with probabilities that should give pause.
Climatic change is probably a long-term proposition that may prove non-negotiable and globally inescapable.
Biological disasters may have a much higher short-term probability of upsetting our applecart, with surprisingly sudden onset and virulence probably devastating.
Just losing 5%-10% of the population, as happened in the 1918 Spanish flu epidemic, would be bad for modern property dynamics, as oversupply would dominate for years afterwards. Never mind another visit of the Black Death or its equivalence, with 10%-50% mortality.
But these morbid scenarios remain outlier horses, although they have always existed and accompanied us through time, and occasionally made a visitation.
Less fanciful is an economic misstep, externally induced and amplified by mistaken domestic choices. We have encountered prime 25% before, or rather real interest rates of 10%-15%. In 1985 our political choices laid the table, but in 1998 it was the interplay of a still exposed domestic situation and global virulence.
The good news about 2001-2002 was that at least we withstood one stress-test. Poor external exposure and a few policy mistakes was enough to trigger a currency implosion. But unlike 1998 or 1985 it didn’t lead to excessive real interest rate premiums and property market dislocation.
Today we do retain external exposure, by way of our very large current account deficit. But we also have created shock absorbers, by way of a flexible exchange rate policy, a fiscal surplus, no major external indebtedness, large external reserves of over $70bn (when viewing public and private resources together) and probably even bigger external borrowing abilities.
Still, policy mistakes are possible, as 1980, 1985, 1998 and 2001 showed, although each episode was uniquely different, making forecasting the next misstep rather challenging. Whatever could they dream up next?
The possibility of excessive real interest rate shocks in excess of 5% is not negligible, going by recent decades, but it probably is also not extreme, provided we don’t need to relearn some lessons from the past. Continuity in politics is therefore important, in contrast to having to pay school fees for any new policy detours.
If, therefore, we may assume we aren’t about to be devoured by political disaster of whatever kind, and won’t incur economic missteps giving us real interest rate shocks in excess of 5%, the property market exposure becomes far more one of internal dynamics.
Those internal dynamics may at times look unappealing, with evidence of institutional decay, slowing growth, and the continuous drain of skilled emigration. Yet the overall dynamics may not be so severely challenging. Indeed, they remain supportive for real property values over time, though with short-term qualifications.
Unlike other countries going through massive housing adjustments at present, we have neither overbuilt nor have our households as yet leveraged as much.
Given the way we are organized, favouring low household saving, high consumption, appetite without end and an obliging producer culture, the current property market disturbance may in fact just be a minor cyclical interruption in a long uptrend towards much more leveraging, both in terms of property ownership (in spread and depth) and financing.
But those are long-term choices. What matters in the short-term are the nature, extent and duration of the property market interruption currently being experienced.
The US experience may serve as useful benchmark. Former Fed chairman Alan Greenspan had some interesting things to say in a Financial Times article in March 2008.
He opinioned that the current US financial crisis will end eventually when US house prices stabilize and with them the value of equity in homes supporting troubled mortgage securities. With losses realized rather than still prospective, the major source of contagion will have been removed.
Although inventories of vacant houses held by builders and investors have recently peaked, liquidation of these inventories needs to start in earnest before house prices can stabilize.
According to Greenspan, writing in retrospect, the US housing bubble peaked in early 2006, followed by an abrupt and rapid retreat since then. Since mid-2006, hundreds of thousands of US homeowners have moved out of homes into rental housing, many forced by foreclosures.
This has created an excess of about 600 000 vacant, largely investor-owned single-family units for sale. Homebuilders caught by the market’s rapid contraction have involuntarily added a further 200 000 newly built homes to the ‘empty-house-for-sale’ market. Thus there currently exists a surplus of 800 000 units.
US house prices have been falling rapidly under the weight of this inventory overhang.
Single-family housing starts have declined by 60% since early 2006, but have only recently fallen below single-family home demand.
This sharply lower level of pending housing additions, together with the expected 1 million increase in the number of US households this year, as well as underlying demand for second homes and replacement homes, together imply a decline in the inventory of vacant houses for sale of about 400 000 units during 2008.
The pace of inventory liquidation is likely to pick up even more as new-home construction falls further.
The level of home prices will probably stabilize as soon as the rate of inventory liquidation reaches its maximum, well before the ultimate elimination of inventory excess. That point, however, is still an indeterminate number of months in the future.
By that point in time, Professor Shiller expects US house prices to have declined by 20%, Goldman Sachs today is punting a 25% number and others are all in the 10%-20% range. It will have become the first serious US house price decline since the 1930s.
How does the South African situation shape against this backdrop?
We unfortunately don’t have such precise housing data, but can still try to paint a picture.
There are some 12-13 million households in South Africa, with a formal sector ‘bankable’ housing stock of some 5-6 million units.
New formal sector building of houses (over 80 square metres), townhouses and flats adds an average 60 000 units to this housing stock annually. Affordable house building was until recently adding a further 40 000 smaller sized units annually.
This in a country where population growth may have dwindled, but where African immigration is high, in which the larger cities continue to grow at a rate of over 3% annually (at least 200 000 households annually, but probably more), and where the housing backlog (pent-up demand) remains enormous (at least 2 million units of subsidized and affordable housing wanted but simply not available).
Although the 4% increase in interest rates since mid-2006 intensified the affordability problem for many indebted households, South Africa hasn’t developed the kind of excesses as seen in the US.
One important reason is that our mortgage interest rates remained mostly market-related.
Our vacant houses inventory hasn’t soared on a comparable US scale.
Yet our building activity is now also dropping, not as precipitously as in the US, but still noticeable enough at plan stage, to be followed in actual buildings completed this year.
One reason for the falloff in house building is the household affordability problem due to higher interest rates. But an even bigger problem seems to be facing builders on the supply side when it comes to municipalities providing bulk services and Eskom providing electricity supply.
Indeed, the building falloff induced by the supply side problems may well start to compare relatively with current US house building conditions ere long. Yet South African households could probably absorb a few hundred thousand units of affordable housing annually even at present interest rates, if only such housing were built.
This state of affairs invites a number of observations.
If our nominal interest rates were to rise further on account of a commodity-induced inflation bulge yet to peak, the affordability problem for households would intensify in the short-term and housing demand and supply could be further disrupted.
One would expect over time that political priority of more house building will eventually lead to focusing on municipal and electricity bottlenecks. This, however, may take time to organize. In the meantime, new building activity is likely to undersupply the market.
In a fundamental sense, South African housing demand will continue to grow, as the inflow into our cities continues and as the economy continues to expand, further increasing formal employment.
This suggests continuous annual additions to working class and middle class ranks. Together with the backlogs from the past yet to be addressed, this suggests a robust long-term housing demand picture.
As in the US, we are going through a housing market disruption, except that our excesses didn’t come close to US conditions, we haven’t seen similar numbers of people exiting the housing market, we don’t have as large a vacant inventory, our new supply is falling if mainly for different reasons, yet our pent-up demand is much larger.
Whereas in the US it is the pace of inventory liquidation that is the key to house prices stabilizing, in South Africa it appears more an old-fashioned interest rate cycle disruption.
The good news here is that we are already two years into policy tightening, with the larger part of any cyclical adjustment already absorbed. As to rates of change, the inflation RATE will peak this year, and thereafter start coming off, even as we debate likely peak level and timing thereof and rate of descent thereafter under the impact of global commodity prices, the Rand and Eskom electricity price shocks.
If nominal interest rates were to be increased further, it is unlikely to be a stiff increase. In turn, this would probably mean further worsening the short-term affordability problem of households and consequently the further deepening of the housing market adjustment and prolonging its occurrence, but this is unlikely to be on a scale as presently witnessed in the US.
Once we are passed such a cyclical peak (if indeed we haven’t already arrived on an interest rate plateau since last December), the eventual easing of inflation may be followed by some modest cuts in nominal interest rates through 2009-2010 in order to prevent real interest rates from rising too far. That in turn should give rise to renewed, if gradual, belt loosening among households, also in the housing sector, following today’s belt tightening.
Source: Cees Bruggemans, Chief Economist, FNB, April 1, 2008.
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