There are many optimists out there who predict that house prices will start to recover by the end of 2009. Let’s think this one through…

'Recover' needs to be defined, of course. If it means that prices will stop sliding in nominal terms, then this is remotely possible. But nominal prices that stop sliding are not the same as any meaningful rise. To rise significantly prices have to exceed rises in inflation, which could either be regarded as consumer inflation (as in the CPI) or replacement costs.

So how realistic are the medium-term prospects for real growth?

Prices are in real terms still exceedingly high compared to the real peaks of prior cycles, for instance the previous peak in the middle of 1984. These high values are the result of prices having risen much faster than incomes for many years indeed. In fact, since about 2004, house prices in South Africa have been well above their long-term trend line (1966-2008). In our book, that is another way of saying prices have been in a bubble since this date. Such a situation is evidently not sustainable, and the prick of the bubble had to happen sooner or later. The prick is normally a sharp rise in interest rates as the economy runs out of capacity; but this time around it was the world economy that provided the initial wake-up call. Historically, in this country these corrections haven’t been apocalyptic. Rather, what typically happened was that nominal prices would decline by up to 10 percent initially and, thereafter, real prices would decline for many years until prices are once again in line with incomes and interest rates on mortgage bonds.

But there are additional reasons to be suspicious about a vigorous turnaround in the prices of houses, namely the cost and availability of credit.

First, the cost. During the boom times the banks as mortgagees were in cut-throat competition with one another to lend to the public, chasing volume at the expense of profit margins. Interest rates of prime minus two percent were common. Now, with sales volumes down and risks higher, banks can no longer afford these tight spreads and are forced to restore margins. As a consequence, prime plus two percent is now common.

Incidentally, and this is of crucial significance, this ratcheting-up of margins has effectively neutralised the cyclical lowering of interest rates by the Reserve Bank. Put differently, for the man in the street servicing a (new) mortgage bond, interest rates haven’t come down by much.

Go to page two for more reasons to be pessimistic about property...

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