Real Estate news - The global credit crisis clouds the outlook for residential property

THE global credit crisis took a dramatic twist in recent months, triggering intense panic among investors, throwing equity markets worldwide in a tailspin and forcing unprecedented government and central bank intervention in most industrialised countries.

SA was not entirely spared. The global selling frenzy left our equities, bonds and currency bruised. While some of the panic in the markets is starting to ease, the effect on the world economy is only beginning to emerge. The economies of the US, the UK and Europe are already shrinking, and a global recession is now widely anticipated next year. This will undoubtedly undermine local growth prospects, which in turn could place more strain on an already subdued residential property market.

Why a global recession?

The underlying cause of the global credit crisis is a massive and unsustainable build-up of debt over the past decade or so. Abundant liquidity and low interest rates encouraged households to spend and borrow without restraint and businesses and investors to amplify returns through leverage and financial innovation.

It now seems at best naive, but at the time rising asset prices, especially house prices, concealed the dangers of the explosion in debt. In 2004 US interest rates eventually started to increase, defaults started to rise, especially in the subprime mortgage market, and house prices started to fall.

Banks came under severe pressure as defaults continued to mount, ultimately forcing massive write-offs, eroding capital adequacy and restricting lending. As suspicion between banks increased, capital was hard to come by and raising funds in the interbank market become equally difficult and increasingly expensive. Ultimately several banks failed and liquidity evaporated as interbank lending ground to a halt.

In recent weeks massive government interventions have restored some functionality to the banking market, but the painful but necessary process of deleveraging has now started, with households and corporates worldwide forced to reduce debt levels and limit future borrowing.

This implies less spending, lower production and less investment in most sectors, and therefore much weaker economic growth. As a result, even official forecasters such as the International Monetary Fund (IMF) have revised their outlooks down, forecasting much weaker growth for 2008 and a recession for 2009. Most industrialised countries are expected to slip into recession in late 2008 and 2009, while slower growth is expected from emerging markets and other developing economies over the next two years.

How will the crisis have an impact on residential property?

This nasty turn comes at a bad time for the local property market, which was already under strain prior to the intensification of the global crisis. Demand for real estate has weakened as households struggle to cope with rising inflation, higher interest rates and relatively high debt burdens. As a result, growth in house prices was already slowing sharply off a high base, with some indices suggesting house prices are falling in nominal terms.

Until recently, therefore, this tougher financial environment was mainly responsible for the weakness in the housing market, and any let-up in the form of falling inflation and lower interest rates could reasonably be expected to bring about some improvement in real estate activity and therefore house prices. However, a possible global recession now threatens to delay any recovery. Weak activity in key markets will hit local exporters, particularly in the mining and manufacturing sectors. These industries are likely to see profitability dwindle as export volumes and prices come under significant pressure. This could result in some restructuring and job losses, denting confidence and containing spending and borrowing even further.

Subdued conditions in key export sectors may also start to affect the performance of other sectors, such as construction and engineering, which have been mainstay of the economy for much of this year. Up to now these sectors have benefited from continued strong growth in fixed investment activity, partly driven by the infrastructure drive of government and public corporations, but also by robust capital outlays by the private sector, which has largely consisted of large projects in mining, manufacturing, residential property and retail trade industries. Some of these projects may now be reconsidered as profits come under increasing pressure, which in turn could reduce demand for building, construction and engineering services, and possibly contain income growth and employment in these more buoyant sectors. The longer and deeper the global recession, the more severe these effects are likely to be and the greater the risk of SA entering recession. Under these circumstances, demand for housing will weaken, putting house prices under pressure.

Fortunately, the financial environment should improve next year, bringing some relief to households. Inflationary pressures are expected to ease further, helped by sharply lower global food, fuel and other commodity prices, the general deflationary world environment and the fading pricing power of local retailers and producers as domestic demand continues to moderate. Although a weaker rand remains a worry and is likely to temper the easing in inflation, there is scope for substantial monetary easing and interest rates should end 2009 about 200 basis points lower than at present.

In short, conditions are likely to worsen in the short term, possibly pushing and keeping house prices in the red for some months, but ultimately falling inflation and lower interest rates, combined with a more positive mood ahead of the 2010 FIFA World Cup should help bring about a recovery in the property market.

Article from: http://allafrica.com