Many people believe the myth that house prices always go up, however, John Loos, household and property sector strategist at First National Bank (FNB) Home Loans, pointed out that this is not always the case.
“One of the big myths surrounding the residential property market is that house prices always go up. This is absolutely not true. Granted, in a country such as South Africa, which has a significant general inflation rate with regard to consumer prices and wages, house prices over time should go up more than they go down,” said Loos.
However, Loos highlighted that over the 50 year history of the Absa National House Price Index, “there has only been an annual average nominal house price decline in three of the last 48 years.”
He added that it is more common for there to be national “corrections”, where house prices inflate, but at a lower rate than consumer price inflation.
Depreciation in property value
According to Loos, the problem with fluctuations in house prices is when home buyers and sellers do not consider the possible depreciation in the value of the property, often making decisions on the false belief that the value of the property can never drop.
“They can be “over-committed” financially as a result, often taking out a 100% loan-to-value bond (plus, sometimes, more debt to finance transaction costs or furniture and appliances for their new home). While the other debt is unsecured, the assumption behind the 100% loan-to-value bond, made by both the lending institution and the home buyers, is that the home’s value will hold, and even increase in time, thus providing “cover” should financial tough times arrive and the household not be able to service the loan,” explained Loos.
In cases where the value of the property does increase, the house can be sold and the outstanding debt can be settled. However, the problem arises when the value of the property drops. The value of the bond that a homeowner takes out when they purchase a property does not decrease when the value of the property does, meaning that you can end up paying more than your property is worth. This scenario is often referred to as ‘negative equity’.
This means that if the property becomes unaffordable or you need to sell for any reason, and the value of the property has dropped, you could still end up owing the bank or the mortgage service provider for a home that you no longer inhabit.
Affordability of homes
Loos highlighted that the “FNB Estate Agent Survey estimates that 13% of sellers are selling in order to “downscale due to financial pressure.” That is a significant number, and it was far more significant around the 2008/9 Financial Crisis period.”
Furthermore, Loos noted: “The big problem here arises when home values fall, because it limits the financially pressured households’ ability to “trade out” of their properties.
“The home can still be sold, but if it can only fetch a lower price, it can mean that there is still some bond debt outstanding. This is the key reason why banks and homeowners alike would almost always like to see home values rising.”
While house prices have been increasing, Loos pointed out that the FNB House Price Index shows a gradual decline in the pace of inflation over the last year-and-a-half. This is as a result of the weakening economic growth rate, as well as rising interest rates.
“Whether the index turns to all out decline or not in the near future will depend much on whether the 2nd quarter’s contraction in the economy will continue into full blown recession or not, and much of that depends on outside forces such as China and weak commodity prices.
“But even if the house price index does not decline, it is important to understand is that the index represents the national average house price growth trend. When a national index reaches even low positive growth, the chances are good that there is a portion of homes whose values are in decline, because not all areas perform exactly the same,” highlighted Loos.
Furthermore, Loos noted that the value of properties for households under financial strain are likely to depreciate due to the cutting back on the maintenance of the home when the owner can no longer afford the upkeep.
Tips for home owners
“It is important that home buyers understand the risks and act accordingly. The usual advice in such times normally goes about limiting borrowing or spending commitments, and there is nothing wrong with that in principle,” said Loos.
However, he added: “We suggest that it goes further than merely limiting the two in isolation, but also to consider how certain credit-driven purchases can impact on non-credit driven spending commitments. One can do this by considering limiting the size and value of one’s home. The house is the one item that influences spending commitments more than any other single item. The implications extend to home maintenance, the rates and tariffs bill, insurance, and of course all of the furniture, fittings and appliances that we fill our homes up with.”
Taking this into consideration, Loos pointed out that smaller properties will have fewer financial needs than a larger property, as the cost of maintenance, as well as electricity, rates and tariffs would probably be less. Insurance costs for a smaller property may also cost less than for a larger home.
However, Loos noted that if the market is declining, there is nothing that you can do to stop it from affecting the value of your property. Loos believed, that purchasing a property within your affordability means, and placing a sizable deposit can assist a homeowner, as “a lower loan-to-value provides something of an extra safeguard should home values decline, increasing one’s chance of being able to “trade out” of a property should tough financial times hit.”