Comment – By economist John Loos (Part Two of Three)

The series of interest rate hikes, coupled with extreme house price inflation, had driven what is arguably the most important measure of affordability to its worst levels on record by 1983.
The ratio I am referring to is the repayment instalment value on a 100% loan on an average-priced house, expressed as a percentage of average income (in index form).

Such levels of “in-affordability” could conceivably be maintained in a thriving economy, but when stagnation returned following the brief growth boom, there was only one way for real house prices and that was down.

And that was the environment,which contributed to SA’s only house price “crash” in over 40 years.

How does the current environment compare?

Well, glancing back at the real house price levels, you may be tempted to say that we’re at far more risk now than even at the peak of the 1980s boom, with real house rice levels today far higher. And as at late last year real house price levels were still rising. Such an assertion would be too simplistic, however, as sustainability of house price levels has everything to do with what the market can afford and not what the price level is.

What the market can afford is determined by the combination of price, household incomes, interest rates (for many households) and overall levels of indebtedness.

Going back to affordability, which combines all of the above factors except overall indebtedness, one will see that the recent boom has not seen affordability deteriorate nearly as badly as the early 80s.

The index reflecting the average house price/average income ratio (more relevant for the cash buyer) has shown a sharp increase since the late-1990s, but is still not back at early-1980s levels.

Due the massive interest rate drops from 1998 onward, though, the index reflecting the ratio of repayment instalment value on a 100% bond on an average priced house/average income has risen far less extremely, and at a reading of 181 by the second quarter of last year was still far lower than the 297 level reached at a stage in 1993. This containment of the deterioration in affordability is not only due to interest rates but also in part to strong household disposable income growth as a result of a strong economic growth performance in the current decade, growth, which has been far more stable and seemingly sustainable than the boom/bust cycle of the early-1980s.

The continuation of this solid growth performance is crucial in staving off the risks of collapse in the housing market. And risks there are. Globally, the increasing possibility of a US recession looms large, while locally it is the spectre of rising interest rates that threatens growth. If we were to go back to interest rates near 20% (or even above), then indeed significant real house price decline would most probably be on the cards. This would contribute directly to the affordability deterioration for credit home buyers, as well as indirectly by stifling job creation and
income growth.

So one’s view on whether housing is in trouble or not must essentially be driven by your view on interest rates and economic growth, to name but the most important 2 macro variables.

Based on our expectations for a fairly moderate growth slowdown in 2008, and, if any, only limited further interest rate hiking, a deterioration in the local economic environment to such an extent that it would precipitate SA’s second major housing market crash on record seems unlikely.

The long term economic growth graph indicates that SA has been on a long-term growth acceleration since the early-1990s.

This was to be expected following the end of restrictive Apartheid laws along with boycotts and sanctions, and the country is still positively adjusting to the greater degree of economic freedom that this political change brought about.

So, when we talk about real economic growth slowdown in 2008, we’re talking about to around 4% from an estimated 5% last year, hardly a train smash. Can the US economy’s woes drag SA’s growth far lower than this? It isn’t impossible, but our view is that other regions of the world, most notably East Asia, are these days better equipped to grow endogenously, with less dependence on the US, thus providing an important growth engine whilst the US sorts out its issues. Therefore, we anticipate a soft landing for both the global economy and ourselves despite the US and its sub-prime and other challenges.

But even should the economic and interest rate moves in 2008 prove to be moderate as we anticipate, you may well ask can households keep head above water given their high levels of indebtedness?
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