What is the effect of rising interest rates on property prices in SA?


If you chart real house prices in South Africa v repayments one can see how the 2000’s property boom differs to what happened in the 80’s.

Quoting Absa’s C Luus from his 2003 publication: http://www.bis.org/publ/bppdf/bispap21l.pdf

“The early 1980s saw a massive loss of confidence in the dollar and concerns about spiralling inflation in most of the developed world. Consequently the gold price boomed, reaching a high of $676 on average during September 1981, which had huge positive spin-off effects for the South African economy. At that stage, income from gold exports constituted nearly 50% of total South African export revenue. Rising incomes and a reduction in tax rates considerably boosted households’ net wealth position. Improved liquidity conditions even facilitated a reduction in mortgage lending rates” in 1979 through 1980.

“However, the good times were about to end when the gold price pulled back and interest rates started to increase. The property market held up quite well during 1981 through to 1983, peaking in the first quarter of 1984. But severe pressure on the balance of payments, which sent mortgage rates soaring, together with increasing political pressure from both domestic and foreign sources, caused the property market bubble to burst. During the period from mid-1984 until the end of 1987, house prices declined by no less than 42% in real terms.

From the end of 1986 through to the end of 1991, house prices simply kept pace with inflation. In 1992/93, confidence suffered a setback owing to uncertainty about the political future of the country. With the advent of the new democratic order in April 1994, confidence was restored and house prices recovered somewhat. However, an ongoing exodus of skilled managers and professionals during much of the 1990s served to keep the property market under pressure.

Only in 1998 did the market start to recover on the back of lower inflation and interest rates, higher economic growth, and a much improved fiscal situation. Unfortunately, contagion effects from the Asian crisis caused a massive fall in the value of the rand, which once again caused interest rates to soar by some seven percentage points during 1998. By late 1999, the situation had more or less stabilised, and the house price boom resumed. By mid-2003, house prices had nearly doubled in nominal terms from their early 1998 values.”

If you look at the chart of real house prices v repayments (at constant 2008 prices), when interest rates rose to 24% in the 80′s they forced repayments of an average real R705,786 house in December 1984 on a 20 year mortgage to R14,238 per month.

That was not sustainable, and property prices crashed back to a real R452,116 by December 1986 and repayments of R4,978. So, what does an average house in 2010 at a real price of R921,513 and interest rate of 9% (at constant 2008 prices) cost on a 20 year mortgage? R8,291 per month. Clearly a very different scenario to 1984, although still fairly high.

What if interest rates returned again to 24%? Then repayments on the same average house today would be R18,590 per month! Again, that would be unsustainable and property prices would crash very quickly in the same manner as 1984.

But that is not the case currently, low interest rates are holding repayments down while keeping property prices higher.
Any interest shocks in the future, though, will have a big impact on the stability of future house prices.

Real house price versus repayments in South Africa

Annual average real house prices are plotted against interest rate movements for that year. Where the interest rate moved more than once in a particular year, the average house price is plotted against the last movement for the year. For interest rate history in South Africa click here.

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19 Responses to What is the effect of rising interest rates on property prices in SA?

  1. CJ says:

    Interesting. Obviously here, in SA, as in the UK, artificially low interest rates have been allowing the house prices to resist falling to where they need to be.

    Here’s an interesting experiment – from 1986 to 2001 real housing prices stayed around the long term norm area of R400,000, only going up with inflation ( as they should). So, if that was a normal market, what were interest rates doing – well they varied a lot but the average was about 17%. In other words, interest repayments during a normal period in the market would cost 90% more than they are at present(9%).

    So if interest rates presently were at the normal average level of a normal market, the repayments would be 90% higher than R8291 = R 15753.

    This is higher than the 1984 R14,238 repayment level that caused the 80″s crash.

    In other words, if interest rates were where they should be, and not artificially low, we are way into a red alert crash level according to the above graph – only interest rate manipulation in SA (and worldwide) is preventing the inevitable. People are not as stretched as they should be by the repayments, so they can resist dropping prices. Of course, buyers are still wary to buy houses at prices double what they have been historically, especially as repayment levels (despite the low interest rates) are still at a peak if one ignores the 1981-85 bubble years.

    I would say the above confirms that all is on track and that the crash is on schedule. And as interest rates rise, increasing downward pressure will be put on the crash.

    Finally, notice that at the end of all downturns in the repayment graph, the repayments end up at R 5300. So if repayments are R5300 and interest rates are at the long term norm of 17%, what would the real house prices be to get these figures – the answer is R374,000. Interestingly, that was the real price bottom that happened in 1997. A bit below the long term norm ( but crash corrections always overshoot beyond the norm and then later bounce back to that level).

    So, under normal interest rate levels we would be at crash alert levels and house prices will be dropping 58% in real terms (from R900,000 to R374,000).

    The big question is can artificially low interest rates delay the Tsunami of a house price crash any longer ?

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  2. CJ says:

    I just looked at your “Nominal house price and disposable income” graph over at your “graphs” section.

    Notice that from 1980 to 2000 they tracked each other almost exactly. And then house prices zoomed up way above the trend that had been established. So, obviously the nominal prices need to return to the trend line. Lets allow 3 years for this to happen. The graph would indicate that the present 375 figure would need to drop to around 300 in 3 years time nominally. That’s a 20% nominal drop in house prices over the next 3 years.

    My above post indicates that we need a real price drop of about 58%. So if 20% is nominal, 38% of this will be due to inflation. That would be inflation of 10% a year for the next 3 years.

    And of course, if inflation is 10%, that is 6% higher than it is presently, so add 6% to prime and we get 15%.

    Combine the information in the last post and this and we get an interesting idea of what could happen over the next 3 years. Annual inflation will go up to around 10%. House prices will drop about 7% per year ending up 20% cheaper in 3 years time. Salaries will be just over a third higher in 3 years time. The average house price will be R700,000, but in real terms this will be about R375,000. Bond rates will be just under double what they are now. But in real terms they will be as cheap as it ever gets. And then for the years after this, nominal house prices will then probably go up just below inflation so there will be increases of about 8% a year – that means it might be about 7 years before prices return to what they presently are, even though inflation over that period means everything else, salaries included, would have doubled.

    So if you are into BTL, the house you buy today will be the same price in 7 years time, rents will have doubled but so would your interest payments. So if your rent doesn’t cover your interest payment now, then over the next 7 years you will continue to lose money, and at the end of that time there would have been no capital appreciation of the house. As it is very hard to buy a house presently that is cash flow positive, I would say this is a dangerous game at this present time. A 10% shortfall a year over 7 years means you would have lost you an amount equivalent to the price of the house. Ouch. Remember on the Jean-Paul Rodrigue classic bubble / crash chart, at the end of the crash the mood is despair – well this is how it happens. Investors who thought they were onto a sure thing winner discover to their horror that they are losing money hand over fist and that the only way out is to sell the property at a huge loss.

    Sure, I am going out on a limb with all this, but it all works according to the graphs we have here on this website. And inflation certainly seems to presently be climbing. The timings might be slightly out but the interesting thing is, everything seems to fit.

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  3. Abrie says:

    Prophets of doom: The average REAL house price growth the past 20 years is 4.17%.

    If I BTL a house in 1991, the bond would have been paid off AND I would have had avg real growth of 4.17% per annum over the past 20 years AND rent would be stable in real terms (if not growth). How much of my own money would I have spent over the past 20 years for a paid-off, real-growth, cash-generating asset? Are there any better investments over the long term?

    Even through the big crash of 1984 to 1986, the average real house price growth over the past 44 years is 2.14%. The key is to net be greedy and utilize property investment over long terms (forever in a trust is best).

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    • CJ says:

      Ah, but Abie, the average real price growth from 1966 to 2001, the beginning of the bubble decade, is exactly nil, zero, nothing – that’s how it should be – houses keep pace with inflation.

      And that is why the bubble excess now will return to that place on the graph where the real growth will once again be nil – that means a 55% real price drop.

      Like I said, any properties you have now that are cash flow positive, you will weather the storm but don’t expect the house to appreciate nominally over the next seven years (according to my scenario) – in real terms they will be worth half as much.

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  4. Absolutely, you are correct. Long term investors know this well, it is the short term speculators who get burned by the cycles. I bet you are even looking forward to some decent inflation to devalue your debt faster?

    What I think CJ is referring to here, is its all about the timing of the BTL investment. If you open yourself up to a long haul negative cash flow, then you better be careful. The point of property is to buy an asset that generates cash-flow, or alternatively the (more dangerous) option of buying one that loses cash flow in the short term but grows faster than inflation so that you can sell at a profit. Right now property prices are not going to be in the second option like they were 10 years ago.

    Therefore the challenge is to purchase property that is very close to cash flow positive. However, average rent’s need to catch up to average repayments to start to achieve that. So either rents must rise driven by demand and inflation or prices must stay the same/drop slightly over an extended period to close that gap, or a combination of the two.

    Unless you are a great sourcer of BMV’s?

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  5. Jim says:

    a case of rich getting richer and poor getting poorer.

    People that can buy in cash even at the peak of a crash, will not lose out. The guys that suffers are the average Joes. The guys that can’t afford to tie up money in long term investments because they have families to feed. The first time buyers that over stretch to buy their ideal home…..

    @Abrie; I think the info here are very much based on facts and the comments are based on peoples interpretation of these facts. CJ’s estimations of a 20% nominal crash over 3 years is very well founded. If you have a different interpretaion of the graphs presented. Please feel free to share.

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  6. Frank says:

    Weird economics CJ:

    “Interesting. Obviously here, in SA, as in the UK, artificially low interest rates have been allowing the house prices to resist falling to where they need to be.”

    Interest rates are currently managed according to an inflation targeting model by central bankers, ie core inflation is a key indicator of when to adjust rates. A good central banker will also not be swayed by energy and food inflation to raise rates, as this form of inflation is largely out of the hands of consumers and so raising rates in response to these only makes life harder for the population at large (see Ben Bernanke who has resisted well the push to raise rates in the US, which has very low core inflation). In the US, with deflation threatening, rates have hit the zero lower bound, ie inflation is so low that it would need a negative interest rate of about -4% to match this – thus the need for another instrument to balance the economy and prevent deflation – namely QE.

    I have no idea why CJ thinks an inflation rate of 19% and interest rates of 15% is “normal”. This was highly abnormal, we are in a much more normal phase right now. Rates are not artificially low, they are just responding to the muted, and even low inflationary environment.

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    • CJ says:

      I say “normal” based on historical records over the last 40 years. During the 17 year period where real house prices were positioned at a place that seems to be the 40 year norm ( and where they stayed there consistently, ie nominal prices only going up with inflation) it appears the prime rate averaged 15%. So if everything else is normal, I am assuming this also must be normal.

      The present 9% prime is a 34 year low so I certainly don’t see how this can be considered normal. Especially when all the other charts are also showing we are at extreme peaks that are far from normality and long term trends.

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  7. Koos Uys says:

    Kindly advise what the average growth has been in domestic property over the past 10 years in the Western Cape.

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  8. Hi Koos thanks for the enquiry.
    At this point HPSA is mainly focussed on the national property picture in South Africa.

    If you contact Jaques du Toit as ABSA bank he may well be able to send the regional data to you.

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  9. Nikki says:

    Now that inflation is rising again… what do you expect the side effects will be ito forecolsures? Especially since another interest rate hike is expected minimum by May 2012 according to the top banks.

    Consumer inflation accelerated 5.3 percent in July, more than the 5.2 percent forecast by 19 economist in a Bloomberg survey, according to a government report Aug. 24. The rand has dropped 6.5 percent versus the dollar since the start of August, increasing the cost of imports including oil.
    “We still see inflation ticking up this year,” Nomvuyo Guma, a Johannesburg-based analyst at Standard Bank Group Ltd., said by phone. “The rand’s movements are going to be crucial in determining the inflation trajectory.”
    Rising food and fuel costs will probably push inflation higher than the central bank’s upper target of 6 percent in the fourth quarter, Governor Gill Marcus said when keeping the bank’s key interest rate on hold at 5.5 percent. Inflation is expected to average 6.3 percent in the first three months of 2012 and remain at the upper end of the target range for the following two quarters, the central bank said July 21.

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    • CJ Says says:

      Higher inflation leads to higher bond rates which means people find it harder to pay their bonds which means they are pressured to sell their homes which means they need to lower their prices.

      At the same time, the higher the inflation the greater the “real price” of houses fall, so to some extent, the total nominal house price falls we will need to achieve the required 50% real price fall the charts say we need, don’t have to be so large.

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  10. Nikki says:

    Thanks for the reply CJ. Surely they need to raise the interest rate first for the bond rates to rise?
    I mean, does one ever have a situation of higher inflation, with a static bond rate?
    Also the news reports state that inflation is set to reduce to 8% by April next year despite rising dramatically at the end of 2011 (no idea why). What then?
    Am hoping the Rodrigues chart sheds some historical light on all this…

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  11. Gunter Golke says:

    Well , it’s now 22/12/2012 – the day after the end of the world , and hey , guess what , no rise in interest rates – well , what do you know.And yet , when it comes to consumers buying things like new cars , well , then it’s fine to fork out R750 OOO-OO on an asset that depreciates the moment it is driven out of the show room.This in itself reflects the utter stupidity of mankind – he will rant and rave about how house prices are unaffordable ( nevermind that the brick and mortar will actually appreciate over the long term whilst providing comfort,,shelter,security and all the good things that only a home can provide) , and this same Neanderthal will then justify why a ” bottom of the range Land Rover is a bargain at R500 000-00 , Go figure.

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