Fundamentals are stacking up against residential properties

JOHANNESBURG - Cracks in the already distressed residential property markets will widen when the draconian lockdown eases in stages in the coming weeks.

The current financial situation of South African households is not dissimilar, if not worse than in the UK where a report on UK household finance by IHS Markit released yesterday, indicated that job security perceptions plummeted to a record low while incomes from employment were falling sharply, despite government support.

The residential property market here had displayed weakness even before the onset of the coronavirus crisis. By the end of last month, the FNB House Price Index had already lost momentum as year-on-year gains dropped to 2.8percent compared with 4.2percent at the end of 2018, while the prices of higher-end properties dropped by as much as 20percent.

The devastating effects of the disruption from the pandemic on the global economy, and especially South Africa, have resulted in massive job losses and severe pay cuts. It is far worse and more abrupt than during the 2008/9 global financial crisis.

The pain inflicted on existing and new-home sales will only appear as the shutdown starts to ease. After falling by nearly 6percent in 2008 from the end of 2007 to September 2008, house prices remained in the doldrums for 12 months. They only reached 2007 prices again three years later. Some segments in the residential property market took a lot longer to recover.

In normal times when negative factors such as interest rate hikes or political utterances, would-be sellers withdraw from the market as buyers drop their prices, leading to slightly lower prices and a lull in the market.

In the current Covid-19 crisis, you could expect the worst scenario with an avalanche of properties put on the market, with no buyers in sight.

Some homeowners are highly geared, meaning that if interest rates go up their monthly bond repayments will eat into their other disposable income. Normally, some lenience is given by banks and other bond holders by extending the duration of the loan, and thereby easing the payback pain in the short term When you lose your job or have to take a pay cut, you still need to service the bond and might end up being forced to sell the property.

In many cases of what the Americans call the,“mom and pop landlords”, who own other residential properties as investments and supplement their income, the rent on those properties are used to cover bond repayments. The lay-offs, forced unpaid leave, and pay cuts are likely to result in people not being able to pay their rent and will probably seek cheaper rents elsewhere.

Although some of the landlords will show compassion, many will still need to service their bonds.

Holiday homes are the first to take the plunge as people dash for liquidity to service other debt such as home loans, especially in the case of lay-offs and forced early retirement.

The investment case for existing and new housing in the middle to upper price-brackets is poor.

From an investor’s point of view, the fundamentals are stacking up against residential properties. Residential property was one of the best stores of wealth among the asset classes for South African investors over the past 10 years, with steadily improving prices and low volatilities.

Residential property prices as measured by the FNB House Price Index outperformed the JSE All-Share Index by more than 5percent a year over the past five years based on capital values, and outperformed the JSE SA Listed Real Estate Index by more than 28percent a year over the same period.

The residential property market now has to compete with listed Reits after the recent major sell-off in risk assets. To mitigate short-term volatility - the price movements of Reits in South Africa are highly correlated with longer-term government bond prices - I look at rolling two-year capital returns of the FNB House Price Index and Growthpoint as proxy for South African Reits.

The average gap between the two-year capital growth rate of the FNB House Price Index and Growthpoint’s share price has bee about 13percent since the end of 2013. The recent slump in Reits saw the gap opening up to 60percent.

Commercial and residential properties are not strictly comparable. From a pure investment point of view, mom and pop landlords’ residential properties and Reits are comparable, because the income on the two asset classes are by and large rent-related.

At this stage, the implosion of Reits, such as Growthpoint, indicates that a significant contraction in rent and property values is already priced in. The same is not yet evident in the residential property prices in general.

At some stage the two-year growth gap will narrow, that is unless we are entering an era where a massive fundamental change in the property market - residential and commercial - is under way.

The longer the shutdown and emergency measures, the harder the impact on house prices will be as the number of delinquencies can easily exceed those recorded in the 2008/9 crisis.

South African homeowners are, therefore, facing a possible second wave of wealth destruction after enduring the hammering on their savings and deferred income through retirement funds and products.

The government, banks and other bond holders are already taking steps to soften the blow and ensure that most homeowners and those who rent residential property keep the roofs over their heads in these unprecedented times. Much more is needed though.

The government should ensure that the banks and lenders refrain from more stringent requirements for new borrowers amid the unprecedented economic uncertainty, and even force banks to cut mortgage rate by another 100 to 200 basis points (2percent).

Many mortgage loans emanate from many years ago when house prices were significantly lower, and outstanding balances are low. Banks and other financial institutions could easily and with low risk allow these homeowners to increase their borrowings to the original mortgage amount. That could add a significant boost to the economy.

The general perception in the market is that the drop in house prices will be short-lived and it could be similar to the blip that occurred in China, where the property market recovered sharply, within a few weeks.

South Africa’s circumstances are incomparable with China, as the latter has the financial resources. Policies to boost the economy are strictly enforced by the People’s Bank of China and provincial governments that take their instructions from the central government.

In my opinion, local residential property prices will be under severe strain in the coming months or even longer before turning for the better - the so-called J-curve.

If you are a homeowner and reside on the property, do not view it as an investment that you can liquidate easily - nor should the bank.

A roof over your head is a must have, and if you can afford it protect it with all means possible - even if you have to cut all non-essential expenditure for the foreseeable future and, if possible, try to get a temporary job or a second job.

Look past the dark clouds of Covid-19, but be very wary of taking on a second mortgage on your property.

Ryk de Klerk is an analyst-at-large. Contact rdek@iafrica.com. His views expressed above are his own. He has a direct interest in Growthpoint. You should consult your broker and/or investment adviser for advice.

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