Market Conditions

Private Property South Africa
John Loos

FNB Property Barometer shows National Credit Act and interest rates biting the market

The release of the second quarter results of FNB's Property Barometer, a survey of

market conditions as perceived by the estate agent industry, shows a sharp

resumption of weakening in market conditions since the first quarter.

In the graph below, the second quarter data point shows deterioration from a

first quarter level of 6.7 to 5.8. There was also a clear decline in that

portion of respondents reporting "very active" and "active" conditions, and an

increase in the portion reporting "stable" and "not very active" conditions.

This decline reflects a resumption of the market slowdown, after a mini-surge

during the latter part of 2006. It is possible that the mild improvement late

last year was partly due to significant transfer duty relief in 2006. On top of

that, we did see economic growth holding up well in 2006, and the combination of

solid economic growth and transfer duty relief may have been enough to offset

the negative impact of rising interest rates for a while. That

mini-strengthening in 2006 was also seen in the figures for new mortgage loans

granted, whose growth accelerated through much of 2006 and early-2007.

But alas, all good things come to an end, and the resumption of the weakening

trend is much in line with expectation.

In addition, FNB did a further survey in July, in order to ascertain the

strength in the market following the implementation of the National Credit Act (NCA).

It is clear that there has been significant further weakening between the second

quarter survey and the July one. From a 5.8 reading in the second quarter, a

further drop to 4.96 was recorded, and the "very active" and "active" responses

became insignificant in July. This is the weakest reading since the inception of

the Barometer back in 2003.

FNB residential property barometer~

How does one interpret this reading? Well, firstly, we must be careful to

apportion all of the blame for the July reading on the NCA implementation. It

must be remembered that some of the negative impacts of last year's four 50

basis point interest rate hikes will still be feeding into the market with a

lag. Secondly, we saw a fifth 50 basis point interest rate hike in June,

coinciding with NCA implementation, and besides the further deterioration in

affordability that this rate hike caused, it is also possible that it raised the

"jitters" regarding future interest rate movements. Thirdly, we have witnessed

signs of economic growth slowdown during the initial stages of 2007. This,

coupled with a mild rise in inflation, will exert some downward pressure on

household disposable income growth. Finally, we had no significant transfer duty

or personal tax relief in this year's National Budget.

Nevertheless, there are widespread reports from banks regarding an NCA-induced

slowdown in mortgage loan approvals, so it is realistic to believe that the NCA

has played a significant role in the slowdown in the July barometer reading.

Indeed, the survey respondents also indicate a strong impact from the NCA. 43%

of respondents claim that applicants are struggling to qualify for home loans.

In addition, respondents are claiming that the lower end of the market is harder

hit by the NCA, with 67% claiming the NCA to be a significant hurdle. Those

operating in the upper end of the market suggest that buyers are more immune to

the NCA because of a significantly greater proportion of cash buyers in this


Again, a caution regarding the interpretation of this result should be issued.

This does not imply that the lower end of the market will perform more poorly

than the higher end. To the contrary, it is likely that the lower end will

continue to outperform the higher end in the near term. One must remember that

there are other non-NCA forces that militate in favour of the lower-priced end,

and which may continue to outweigh the negative impact of the NCA.

A widespread affordability issue has affected the market in recent years. As

general house price levels have risen, so a portion of demand has shifted

towards the lower end, and in the more recent stages of the property boom the

lower end has outperformed the high end as a result. Although there are more

cash buyers at the upper end, it is plausible that the affordability issue

continues to shift some demand downwards to the cheaper end, and this could

compensate for those at the lower end who struggle to qualify for loans.

The Barometer also reports a further drop-off in the proportion of first time

buyers in the market at the post-NCA July survey. After remaining unchanged at

20% in the second quarter survey, the percentage dropped to 16% in the July


This is believed to be the combination of the further June interest rate hike

and the NCA implementation. First time buyers are overwhelmingly credit buyers,

and more often than not they are not at the high end. One can thus assume

significant sensitivity to the NCA

Proportion of first time buyers

The Barometer also reports foreign investors remaining at approximately 5% of

the market on a nationwide basis. Given the debate regarding foreign ownership,

and government noises regarding possible restriction of foreign buying, it is

significant that this percentage is not declining.

However, given a decline in overall activity levels, a constant 5% foreign buyer

proportion would suggest a possible decline in foreign buyer numbers in the

local market. There could be numerous reasons for this. Firstly, there exists

the possibility that some could be holding back in order to see what government

does in the way of foreign ownership restrictions. Secondly, these investors

could be losing interest due to deteriorating performance in the local property

market. Finally, it could also be the weakening of many of their own property

markets that is causing property in general as an asset class to lose its shine

in their eyes.

Also important to remember, when drawing conclusions as to the extent of foreign

ownership, is that if foreign buying is 5% of all buying, this does not mean

that foreign ownership is 5% of all ownership. It is possible that foreign

ownership could still be significantly less than 5%, given the historically low

levels of foreign interest in SA.

A further indication of the market slowdown comes in the form of a survey of how

many properties are sold at below the asking price. This figure has been on a

broad rising trend since early-2004 where it was near to 30%. The post-NCA July

survey recorded a figure of 75% of homes being sold below asking price. This

reflects a further increase on the Second Quarter figure.

Sold at less than asking price

The next survey component, namely the average length of time that a house is on

the market, has also been on a broad rising trend since 2004, reaching a level

10 weeks by the second quarter of this year. This figure remained unchanged at

10 weeks in the July survey. However, it could be that the second quarter and

post-NCA surveys were too close together to make a difference to this variable.

The Barometer also points to further weakening in the buy-to-let market. In the

early stages of the Barometer's history, in early-2004, the proportion of buyers

that bought to let was near 30%. In the July survey, this percentage has reached

12%, down on the second quarter figure just above 15%. This is seen as the

result of deteriorating capital growth as well as a rental market that, until

last year at least, had been on a weakening trend in terms of rental inflation.

With rental inflation believed to have been below capital growth for some years,

the market is believed to have experienced significant yield compression during

the boom years, having a negative impact on the attractiveness of buying to let.

Proportion of properties bought-to-let

Regarding the NCA, noteworthy is that there is a widespread belief amongst the

industry professionals surveyed that the NCA process has slowed the speed at

which loan deals are approved. However, they are optimistic that many of the

stumbling blocks related to NCA implementation will be resolved in the coming

months. Initial concerns regarding the NCA manifested themselves in a drop in

the second quarter reading for the percentage of respondents expecting either

unchanged or improved activity levels in the following quarter. In the July

survey, however, this number of respondents rose to 77% of the survey.

Positive outlook for the next quarter


Those were the key barometer results, but how do I see the market going forward?

Well, despite agents expecting an improvement in activity levels in the third

quarter, following a significant drop, I do not believe that we are yet at the

bottom of the short term property cycle. This, I expect, will only arrive in the

first half of 2008.

What has to happen first? Obviously, key to the recovery in the market is for

demand to once again get ahead relative to supply.

A deterioration in the interest rate environment post-2003 (first in the form of

moving from aggressive rate cutting to broadly sideways interest rates and then

from sideways to rate hiking in 2006) has hampered demand growth. Currently,

real disposable income growth is believed to be hampered by the combination of

slowing economic growth and higher inflation, also constraining housing demand

growth mildly.

However, the expectation is that things will turn for the better in 2008. No

interest rate cuts are expected until 2009, but after one further 50 basis point

interest rate hike in the current cycle, the peak could be reached. A shift in

the interest rate trend from upwards to sideways represents an improvement in

the interest rate environment. Simultaneously, inflation is expected to subside

mildly in 2008 after a small surge has created a high base, thereby contributing

positively to real disposable income growth.

On the global economic front, an economic growth recovery is anticipated from

2008, after a weakening during 2006 and the current year. The US interest rate

cycle is believed to have peaked, while the sub-prime housing market credit

issues are expected to have largely played themselves out by next year.

Improvements on the global economic front, a peaking in SA's own interest rate

cycle, and a mild decline in domestic inflation, are expected to contribute to

slightly stronger local economic growth in 2008, accompanied by stronger real

disposable income growth.

The slowdown in economic growth during 2007 is not expected to be severe,

perhaps to 4.8% from 5% in 2006. This implies positive net job creation and

ongoing strong growth in middle class numbers and purchasing power. All the

time, therefore, demand for housing for primary residential purposes is growing

steadily. Is the supply of new stock keeping up? I'm not sure that it is, given

that over the past 2 years (2005 and 2006) there has been a mild decline in new

residential stock delivered to the market.

Over the next few years, the pace of construction activity should by all reports

be frantic as 2010 approaches. The residential property building sector will

have to compete for increasingly scarce skills and materials, not to mention

services such as electricity supply to new developments. All of this is expected

to constrain the further growth in new supply of residential units.

My thinking, therefore, is that as a result of the combination of steady demand

growth and constrained supply growth, demand (for both rental and

"owner-occupied" stock) will once again catch up with supply, resulting in

acceleration in both rental and house price inflation. Which acceleration is

expected first? Rental inflation acceleration is expected to precede the

recovery of the (currently slowing) house price inflation rate.

Gross rental yields, i.e. rental income expressed as a percentage of the value

of house value, have been generally declining in recent years, with house price

inflation outstripping rental inflation. But you will have noticed in a previous

graph that buy-to-let activity relative to total market activity has been

declining, thus curbing growth in supply of rental stock. Trafalgar's rental

indices have shown vague promise of a rental recovery as demand starts closing

in on supply, but the picture is still very mediocre, and a recovering Joburg

rental market seems to be the main driver of the national average. More

convincing signs of a rental market recovery are expected by 2008, with the NCA

implementation playing a role in driving some additional households into the

rental market due to their falling short of affordability criteria when applying

for home loans.

A house price inflation recovery is expected to follow shortly after the rental

inflation acceleration, in 2008, and the combination of rising rental and

capital growth is expected to once again improve the attractiveness of the

market for buy-to-let investors.

And if high building cost inflation accompanying the various constraints on

delivery of new housing stock is not enough to raise optimism, increasing land

scarcity around major urban areas should. Land with the necessary infrastructure

and services is scarce, and local government ability to deliver this

infrastructure is also limited at present. So not only should high building cost

inflation drive strong returns on existing property, but so too should the land


Therefore, although the estate agents surveyed in the FNB Property Barometer

point to an expected improvement in market conditions in the third quarter, I am

sceptical whether it will happen that soon. But in 2008, with economic growth

expected to recover mildly, interest rates to flatten out, and increasing

constraints on the supply side, I believe that the time will be ripe for the

barometer to once again show a strengthening trend, as activity levels pick up

in response to the renewed attractiveness of residential property as an


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