Bubble Wars

Last week saw a standoff between two economists at the YDL Property market update held in Sandton, one proclaiming SA to be in a property bubble while the other claiming the beginning of a sustained boom.

Bad News first

Dr Adrian Saville, Chief Investment Officer for Cannon Asset Managers, assessed the attractiveness of the current SA residential property market from the viewpoint of a fund manager, most notably a contrarian fund manager. Adrian's investment style has been noted and discussed here before in both the contrararian investing article and the analysis of property bubbles. All articles can be found at The Property Game website and both the articles and Cannon Asset Managers results can be found at www.cannonassets.co.za.

Adrian's bad news is that the SA property market has to some extent all the characteristics of a bubble at the moment. First, is property overvalued at present? Using a simple but highly effective GDP model, which links property prices to GDP growth, it is clear that property prices have soared since 1994 and according to the model are some 35% overvalued at present. Second, if property is overvalued does it have any of the characteristics inherent in a bubble scenario? These are ample liquidity, increased use of leverage, increased turnover, democratization of the market and new supply. His view is that not only is residential property expensive, but that the market is increasingly characterised by 'bubble' features.

Lies, Damned Lies and Statistics

Using 1990 as the base instead of 1994, however, leads to the conclusion that property is 8.1% overvalued while a base of 1988 gives us a modest 2.1% overvaluation. The question is: where do we start? Ian Fife, property editor of the Financial mail, also at the presentation, made an argument for starting in 1970, after Sharpeville and before what he terms 'political discounting'. Given 1970 as the base year sees property values undervalued by around 75% at present.

And the good news

Chris Hart, an economist and industry expert, makes the case for property being a preferred asset class.

In an analysis of the SA property market Chris lists the following factors as contributing to property prices in South Africa.

  • Political Discount - since Sharpeville property has been trading at a 'political discount' and only recently has left this stigma behind.
  • Economy - three factors within the economy contribute towards driving up property prices.
    • Low Interest Rates
    • Strong Currency
    • Good GDP growth
  • Demographics- The demographics of South Africa are fundamentally shifting after the 1994 elections and this allows new entrants to the property market.
  • International Context - SA Property is still seen as cheap in relation to other property in the international market.
  • Replacement costs - replacement costs are escalating which in turn drive up property prices.

The SA market can also be compared favourably to the international property market. The differences and similarities are:

  • Relatively low inflation is SA.
  • Buy-to-let market is saturated globally with similar signs in areas of SA.
  • Interest rates are rising globally while SA rates are on a declining trend.
  • Mortgage Equity withdrawal for consumption is rife in many countries while not so common in SA.
  • Ratio of house prices to income still relatively low in SA.
  • Household debt as percentage of household disposable income hit a five year low in SA in 2002 of 56,8% while it is over 100% in many countries.
  • The ratio of mortgage debt to household disposable income is relatively low in SA compared to other countries.


Adrian: Although there are evident structural factors that mitigate the situation, the driver for house prices is ultimately the economy and given the analysis of stretched valuations with evidence of 'bubble-type' factors where value will always regress to fair value, property 'remains an asset class with poor investability characteristics'.

Chris: As Chris Hart observes South Africans are 'scared' of good news, and have been conditioned by 30 years of bad news. South African investors need to take note of the property price drivers and economic anomalies that allow us to enjoy this property boom.

Both sides of the bubble argument carry weight, but if we do accept 1970 as the base year in which to value property in relation to the GDP, SA is approximately 75% undervalued! Which is scarier? To think that we are moderately overvalued at present or severely undervalued? Time will tell. Err on the side of caution. Property investment is a conservative long-term investment and not a get-rich-quick scheme.

Article by: Dave Welmans - (www.thepropertygame.co.za)