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A respectable recovery

11 November 2010

What will it take for property to make a strong comeback?
Property is a cyclical business. That's one of life's few certainties, along with death, taxes and Blue Bulls victories. Property has "mini-cycles", which are small short term "cycles within the big cycle", and it has longer term big cycles which can average from 15 to 20 years. These property cycles are long, because during the Bull phase of a property cycle, big "excesses" get built up due to the greedy nature of human beings I guess.

The bottom of the last big property cycle was around 1998, a time of emerging markets crises and prime interest rate peaking at 25.5%. Pity the poor over-extended bond holder at that time. Thereafter, however, the pace of improvement was nothing short of phenomenal. The SARB had been told to switch away from trying to protect the value of the rand to an official consumer price inflation target of 3% to 6%. As our country's inflation rate had declined steadily from near 20% in the mid-80s to mostly single-digit rates, there was no longer a need for such extreme interest rates. Prime rate was therefore lowered all the way from 25.5% to just above 10% by 2004, and for a highly credit-driven market such as property, this was like manna from heaven.

Demand for property skyrocketed, prices shot up dramatically due to the initial shortage of property stock, and the greatest boom in our recorded history was born. The downside (although very much part of the cycle) was that property and consumer goods crazy households raised their average debt-to-disposable income ratio to a new historic high above 80% by early-2008, and developers piled into the market to create a massive new supply of housing, not to mention a group of property speculators jumping on the bandwagon to drive the boom further than what the underlying fundamentals dictated that it should have gone.

All of this behaviour, however, is very normal, and was also happening across the ocean in the mighty USA, unfortunately it had to end with a fair amount of tears, as it always does. The tears ultimately came when the global economy slowed our own economic growth, and this translated into slower household income growth. On top of this, inflation went through a surge from 2006 onward, driving up interest rates. All of this was a problem, because the household sector was by that time highly indebted, and the deterioration in the economic and interest rate environment meant that scores of households couldn't service their loans. This led to a moderation in housing demand, and after a huge building boom, this translated into a major oversupply of housing on the market, and the resultant price slump.

And so begins the long slow recovery process. Firstly, the fundamentals have to be put in place. These include a multi-year process of reducing the household debt ratio, already two years down the track. Typically, this should be about a 4-5 year process. Simultaneously, development activity has fallen to far lower levels, and this will assist in a gradual return to balance between demand and supply over the next few years. On the other side of the ocean, major economies such as the US and UK have to undergo the same process.

When we get to a better housing market balance between supply and demand, stronger global economic fundamentals, and a significantly lower household debt-to-disposable income ratio, our own property market will be ready for a far more solid recovery. What is the time frame for this? 2015 may not be a bad guess. We are not financially strong enough to respond strongly to low interest rates in the current cycle. Firstrand expects that interest rates could once again begin to rise late in 2011. I wouldn't be surprised if this event gets delayed to 2012. Nevertheless, interest rate hiking cycles always do come, and working on normal time frames, 2012/2013 for a hiking cycle wouldn't be a bad guess. That would probably take us to the next cutting cycle around 2014/15. Lower household debt by that time after a relatively conservative lending/borrowing period, and much of the global financial and economic chaos having been sorted out, should make set the scene for a more sustained property recovery by that point. Working on that other assumption, i.e. that the length of the big property cycle should be between 15 and 20 years, 2015 would be 17 years after the last big cyclical bottom.

Forecasting is never an exact science, but around 2015 for a respectable property recovery seems like pretty good thinking.

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