Can houses drop in value?

Yes. Here’s the South African picture – stats.

In the wake of the panic property buying of the mid-2000s, many would find it hard to believe that house prices can actually drop in value. But they can, and have, dipped below what they are worth.

That's a financially hazardous situation for people who have borrowed to buy an asset because it means, if you don't have sufficient equity - or value - in your home, you can be paying more for your property than it is worth.

And, if you need to sell, you won't clear enough to cover your debt. You will still owe money after you have disposed of your asset.

The big drop

The good news is that house prices in South Africa have not dropped often in nominal (face value) terms.

Going back to Jan 1966 in the data of Absa's monthly House Price Index, homes dropped year-on-year from November 1984 to January 1987.

That was a time when South Africa's political situation looked so dire that even the now-derided Zimbabwean dollar appeared to be a more attractive currency than the rand.

In real terms, or deflating the prices to take into account the effect inflation has on them, residential property has dropped often in past decades, but it has not slipped into negative terrain in the 2000s.

From June 1974 to December 1979, real year-on-year growth was mostly down. Earlier in the 1970s, real prices also declined between positive growth periods.

In the main, though, price tags kept rising.

The average house - the one that now costs just under R1m - would have had a selling price of about R21 000 in mid-1974 and about R31 000 by the end of 1979.

The period from 1984 to 1987 inevitably looked grim in real terms, with the average house costing close to R80 000 in June 1984 and down a little to about R79 000 in September 1987, as you would expect with a decline in nominal value.

However, three months later the market bounced back, putting the average property price at about R83 000 (December 1987).

For much of the 1980s, year-on-year percentage differences in real terms looked poor and they did again through much of the 1990s.

Nevertheless, in mid-1985 the average home cost about R73 000 and by June of 1995 this figure had grown by about R100 000, to about R173 000. In mid-2005, the average home sold for about R700 000.

Riding out the volatility

The message in these figures is that if you buy for the long-term and aren't drawing on your equity, you shouldn't notice a blip in nominal value.

Much like with shares, holding property for a long time irons out price volatility. Unit trust managers and stockbrokers are usually among the first to recommend holding the investments they sell for at least five years and preferably longer, and the same should apply to property.

In the United Kingdom, some commentators expect property prices to dive by a fifth, or a staggering 20%, this year.

Back home, economists suggest things are not that bad for property owners.

Nominal price growth is now at its worst rate in seven years, but it is not expected to decline to the extent that properties start changing hands for less money.

That's assuming, of course, there are no nasty surprises, like interest rates soaring way beyond the expected ceiling or some type of economic or political shock.

Property prices are still chugging upwards but the pace has slowed dramatically compared to recent years.

Jacques du Toit, senior property analyst at Absa - which has been tracking residential property prices based on mortgages for its clients since the 1960s - says: "In nominal terms growth is positive and real price growth is still positive, although it is very low at around 4%."

Price growth is "getting very thin and can even go lower", but for now the Absa economist does not foresee a fall in house prices.

Even if they do drop, residential prices are not expected to plummet dramatically or keep falling for several years. Generally, the trend in nominal house prices since the 1960s has been up.

Bubble vs catch-up

The Motley Fool, a personal finance website, points out that in the UK on average house prices drop at most one or two years per decade.

This is not much to worry about, says the site, "if you can ride out the bad years without being forced to sell up".

"However, it can be nasty if you enter the game just before a prolonged downturn in property prices. Either you're forced to sit tight and ride out the downturn, or you take the loss on the chin."

The same applies to South African property.

Some people believe that property prices this decade reached bubble proportions, or that we have overpaid for properties as a nation, and that prices are set to dive.

But economists generally believe South African property prices rose off a low-base. Homes were cheap relative to other assets and demand for them huge, thanks to a shortage of housing. In addition, the political transformation has brought many new entrants into the market and this is set to continue, fuelling demand for property.

Growth will be more sedate, but the longer-term trend should still be up, is the message from economists.

Time will tell who is right in the debate.

In the meantime, history shows us that the price tags on South African properties have more often gone up than down. Whether property is the best investment option for you, however, is another story.

Artcile by: Jackie Cameron - www.realestateweb.co.za