How to survive the property crunch in South Africa – The beast is back

Pain for many, but opportunity for some as interest rates bite

Home owners, developers and investors can put on their hats and coats and leave: the party's over for the residential property market.

Data from the big banks shows year-on-year housing capital gains continuing at between 13,5% (Absa) and 6% (Standard Bank) - far below the 35% of 2004 . . . and last year.

But read further into their statistics and you will see that prices adjusted for inflation are on their way to negative territory. Absa's latest price index shows real house prices rising just 0,1% month on month. Standard Bank says nominal prices will stop rising by year-end.

The lag in property between deal and data means that the slowdown in prices started before the interest rates rises of June and August.

Absa property economist Jacques du Toit is projecting another 1% rise before year-end. This will bring great pain to homeowners and investors who have borrowed to the hilt.

But they are not the only ones who will be hit by the sudden downturn.

Property developers who have been too optimistic about demand or who got their product wrong will be brought to their knees by slow sales and higher rates.

Some estate agents who grew too fast or became too comfortable after six fat years are struggling. These are said to include Johannesburg agent Wendy Machanik and the Hout Bay branch of Sotheby's.

You can bet on the actual average house price falling by the end of this year, which means real values sagging by 5% or more. Prices in the stable, prime urban areas will probably hold. So the value of some properties outside those areas will be plunging.

Land, houses, golf and gated estates on the coast and inland holiday homes will probably be worst affected, followed by poorly conceived and overbuilt urban developments.

Homeowners and investors stretched by the growing cost of debt will no longer be able to rely on rising property prices to save them and will eventually be forced to sell - into a falling market.

Most of those who'll be in trouble already know it, says Bruce Swain, CEO of estate agency giant ReMax.

"I feel particularly sorry for couples who bought homes in May and borrowed to their limit of affordability," he adds. "A typical family who took out a bond of R800 000 will already be scratching around for about R650/ month more, and it could be close to R1 500/month by early next year."

Others in trouble are buy-to-let investors who were persuaded during the boom to buy new flats and townhouses in burgeoning urban areas off plan. Many applied simultaneously for five or more mortgages so that lenders would not be aware they were far exceeding the affordability guideline of limiting home loan repayments to 30% of gross income. Some will be saved by the rapidly rising prices of two and three years ago, allowing them to take their profit. But others busy taking transfer of the properties they committed themselves to up to two years ago, will be in the vice-like grip of higher monthly instalments and lower rents than they expected, and falling values.

Recent home buyers with little experience of property ownership will also be vulnerable to financial crisis. "It's not their mortgage debt," says Absa home loan chief Gavin Opperman. "It's their total debt including credit card, vehicle finance, hire purchase and personal loan debt in a rising interest rate cycle that I worry about."

In fact, most people who bought residential property in the past six years have had no experience of a property downturn. Those who have, vividly remember the return of the interest rate beast in the 1980s and 1990s - rates as high as 25% and the struggle each month-end for survival for two years or more - when many lost their homes and investments. That level of interest rate is unlikely to return in the near future. But they know what interest rate fatigue will mean to the newly stressed.

Even a two percentage point rise is enough for thousands to lose their properties, particularly when they don't know what steps to take to save themselves.

That 20% rise in interest rates from an average home loan rate of 9,5% to 11,5% will be enough to show up property's biggest weakness - its lack of liquidity.

You can sell your listed shares or cash in your money market savings in an instant. But even now, properties on the margins of the market have suddenly become unsaleable - unless owners are prepared to take big discounts on their market prices of just three months ago. Even then, it may take up to six months to transfer and release from the interest rate burden. This unsaleability will spread towards the prime areas.

Sentiment affects liquidity more than the actual cost of borrowing. Buyers hesitate because they aren't sure what is going to happen next. Young adults who were about to buy their first small flat decide to stay at home for another year. Couples who were about to split up wait and see. Investors aiming at big capital gains see no more reason to buy and exit the market. Demand dries up.

But because the property market is not as transparent as the JSE, it can take months before many homeowners are aware of the change. They decide to try to manage their growing negative cash flows, expecting prices to rise and bail them out. This is a big mistake: they miss the opportunity to sell when there is still some liquidity in the market.

By the time they have to sell, it will be at losses they can ill afford, with their credit ratings reduced to rubble.

Homeowners will find the advice of their lenders and other sector experts comforting. Bank home loan chiefs say they have stress-tested their debtors books with scenarios that include US$100/barrel oil prices and 13% interest rates. Their mortgage debtors book has doubled in three years to nearly R600bn, and that excludes bonds over properties to cover overdrafts. But they believe debtors will continue performing.

"We did start cutting back on loans to buy-to-let investors, coastal areas and golf estates early this year," says Opperman. "But we are of the view that our borrowers can largely afford the projected interest rate rises." Other banks, however, continue to give 100% loans to these sectors.

"There are always individuals who default on their loans, but an excessive increase is not projected. Most people will accommodate the rates," he says.

Neither Swain nor Jan le Roux, chairman of PA group, which includes SA's biggest mortgage originator Betterbond, see the high interest rate regime lasting more than 18 months to two years.

"My gut feel is that the next year or so will not be particularly problematic," adds Le Roux. "And I'm still a buyer."

Gut feel has to play a part in any projections about the future of the market because key information is not available. Banks know that household debt is about 70% of annual household income. But they don't know what percentage of homeowners' disposable monthly income is devoted to their monthly home loan instalments. It's an accurate predictor of mortgage defaults used overseas. Opperman also admits that because banks don't yet have access to a central debt register, they are guessing how much total debt their clients are actually carrying.

This is not a bursting bubble. It is a short, sharp interruption of residential property's long-term recovery from decades of economic mismanagement and political instability. But that will give little solace to those who can't meet their obligations now. Their worst moment is (having stuck out the situation against all odds) to find themselves in sight of the next property upswing but being forced to sell anyway.

There is a chance that the experts' comforting views are correct. Interest rates may not rise to a 12,5% overdraft rate, or last long. Even Du Toit says the one in December "may not actually have to happen if the reaction to earlier rate hikes is what the Reserve Bank wants".

But banks have a history of underestimating both the improvements and the declines in the property market. Bad things have a tendency of coming in bunches, and it seems no different now. A decline in the US house market has finally started. That could affect consumer spending in America and affect the world economy.

The Doha round of the World Trade Organisation (WTO) talks is moribund. This could mean higher inflation and lower economic growth, particularly in the developing world. Tit-for-tat interest rate rises have started around the world and there is no reason SA should be excluded.

The stalled WTO talks and possible growing disquiet about the SA government and ANC obsession with the Jacob Zuma succession issue could increase the risk premium on SA interest rates, as could global warming concerns.

None of these issues may lead to a crisis and the world economy is likely to keep on growing. These are the straws that stressed debtors will clutch at.

Typically, overstretched borrowers tend to behave in the following way:

  • They ignore the problem, comfortable that they have substantial equity in their homes, and believe high interest rates won't go up or last long. They start spreading their income between their car, home and credit card debt, falling behind a little in each;
  • They soon realise they can't keep this up and decide to withdraw some of their home equity by increasing their bonds. If the bank agrees, they use this equity to pay their monthly shortfalls;
  • If further bond advances are refused, they call in estate agents and ask the price they hope to get to expunge their debt, leaving them with enough to buy another house. The overpriced house sits on the market for months;
  • They start serious defaults on their debt and spend much of their time avoiding creditors or making excuses for the default; and
  • They reach the end of the line, often within sight of the market about to turn up again. But it's too late. Their houses are auctioned at rock-bottom prices and all they are left with is residual debt.

This is the wrong way to go about dealing with the problem. Opperman says banks are usually as keen to save the situation as the homeowners.

"The days are long gone when banks simply foreclosed on defaulters and auctioned their homes," says Opperman. "We are eager to work with clients in difficulty. Too much value is destroyed by legal action followed by a sale in execution."

The right way to handle a looming crisis is to face it quickly and get the house on the market while there is still demand (see box, page 26).

"People who come to us early and take drastic action are usually the ones who bounce back quickest," says Opperman. "We can, for example, give them payment breaks to help deal with necessities. If the situation warrants it, we can consider extending their payment term, or consolidate high-interest debt like credit cards into the bond to reduce the instalment. In the event of quick recovery being remote, we can help them sell their properties in a controlled way to get the maximum price."

The SA residential property market remains far behind markets in equivalent countries. Growth in the economy, the prospect of the 2010 soccer World Cup and the continuing integration of black people into the suburbs, make further growth over the next decade certain. Global influences from China and India could add to that growth.

Whatever happens over the next year or two, prices are unlikely to start growing fast, so you will have time to prepare.

If you can clear the decks, you will be able to join the smart money that sees the current interest rate pattern as an investment godsend. It will allow you to buy in properties from early next year, when those who have not dealt with their debt are at their weakest and the market is on the floor.

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