Short-term view can distort residential cycle forecasts
05-09-2005
Property economist Erwin Rode says that his light-hearted remark that from a purely financial point of view it would be smart to sell his home right now, rent for 5 to 10 years, and then buy another home, was premised on the lengthy period of the residential property cycle.
"Clearly I'm not advising people who already own homes to start selling them based on the fact that it is not the best investment to be had. Such a step would seldom be worth the emotional turmoil or the practical implications of having to find another suitable place near to work, schools, or other relevant facilities. There would also be removal and other costs to consider, the person would have to have a good knowledge of alternative investment options and would need to be disciplined enough to save the difference between the monthly rent and mortgage instalment."
Rode says that investors should note that the real residential cycle has historically been a long one, and the downswing phase is, therefore, also generally quite long. Take the early 1970s for example: after reaching its apex in 1970, the residential property cycle went in a downswing that lasted a whole 9 years. That is, for 9 years house-price growth did not exceed consumer inflation.
He reiterates that he stands by the principle that with the real residential cycle currently close to its peak, it is not a good time to buy a residential unit as an additional investment if you already own a home. He predicts that for the next 5 to 10 years chances are slim that capital growth in the residential market will exceed inflation.
"If you buy a flat at a net income yield of 4% while your bond interest is 10%, you are going to finance your bond repayments out of your own pocket for a long time."
Rode says the latest Absa home-price index shows that house prices in June 2005 were 23% higher than the same month the previous year. However, if one compares June 2005 with May 2005, the growth was 1,1%, which equates to an annualised rate of only 13,6%. This is indicative of the tempo at which house-price growth is cooling off. Note that this does not mean that prices are declining; it’s the growth rate that is sharply declining.
Rode points out that it is completely unrealistic to expect capital growth of 12% per year over the next five to 10 years given that consumer inflation is expected to be between 4% and 5%. He says that house prices are currently in real terms (i.e. when consumer price inflation has been brought into account) considerably above the historical peaks of 1984 and the early 70s.
"When real prices are that high, two things happen. On the one hand developers flood the market with new homes because there is money to be made, and on the other hand houses at the top prices become unaffordable because salaries are not growing at nearly the same rate. Should interest rates continue to decline from the relatively low current levels, it merely delays the unaffordability tendency."
