Warning: property prices don't always rise

The home is arguably the purchase that brings about more additional spending commitments than any other for most households. In tougher economic times, aspirant home buyers need to consider the future costs that will come with the type of home they buy, as well as the implication surrounding the fact that home values can decline.

Economic cycles are a fact of life, and households needs to adapt as these cycles unfold.

One of the big myths in 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 when it comes to consumer prices and wages, house prices over time should go up more than they go down.

Indeed, if you view the Absa national house price index for its almost 50-year history, there has only been an annual average nominal house price decline in three of the last 48 years. National "corrections" in real terms, where prices still inflate but at a lower rate than consumer price inflation, are more common occurrences.

Downward corrections either in "real" terms only, or in all- out nominal terms, should not be seen as a bad thing. Ideally, asset prices should reflect the economic fundamentals of the country and of specific regions or areas. If those fundamentals, such as economic performance, deteriorate, asset prices should correct accordingly. This is a healthy, well-functioning market situation to have.

The problem, though, is when home owners are not prepared for an event such as a home value decline, often because they make their buying decision based on the fallacy that the value can never drop. They can be overcommitted financially as a result, often taking out a 100 percent loan-tovalue 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 percent 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 over time, thus providing cover should financial tough times cheaper home, where its smaller bond costs and lower running costs would become affordable, or it could move into a smaller and cheaper rental home.

And, although many of us may think it will never happen to us, even in these current lowinterest rate times, our FNB Estate Agent Survey estimates that 13 percent of sellers are selling to downscale due to financial pressure. That is a significant number, and it was far more significant around the 2008/9 financial crisis period.

The big problem here arises when home values fall, because it limits the financially pressured households' ability to trade out of their properties. The situation is known as "negative equity", a situation where the household owes more on the bond than the home is worth, because the home's value has dropped.

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 home owners alike would almost always like to see home values rising. And with the FNB House Price Index still rising year on year at 4.9 percent last month, there would appear little to worry about because home values are rising, right? Well, not quite.

The reality is that the index's pace of inflation has been gradually slowing for over a year-and-a-half, the natural response to a weakening economic growth rate over the past few years, 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 second quarter's contraction in the economy will continue into fullblown 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 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.

Second, the probability of home values of households that do come under financial pressure are more likely to decline, because part of the response to financial pressure and stress is often to cut back on home maintenance, and so speeding up building depreciation.

And, in a weakening economy, which is where we are right now, job security deteriorates and incomes become less secure, raising the chance of financial pressure. On top of this, we are in an interest rate hiking cycle.

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.

We suggest that it goes further than merely limiting the two in isolation, but also to consider how certain credit-driven purchases can affect non-credit driven spending commitments. You can do this by considering limiting the size and value of your home. The home 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 the furniture, fittings and appliances that we fill up our homes with.

Think about it, the smaller the home, the less space for "stuff " and possibly the less the electricity consumption. The lower the value, the less the rates bill should be ( I say "should be"), and the fewer frills such as garden and swimming pool the less the water needs, and of course the less the maintenance needs and insurance costs.

The more we buy a home within our means, with this myriad of future costs in mind, the higher the probability that the home won't exert pressure on our household finances. This, in turn, heightens the probability that home maintenance can be kept up, and so reduces the probability that the home's value will fall.

But the positive impact of home maintenance can only go so far. If the market is against you, a home's value can still decline.

This is where there are potential safety benefits to buying well within your means and being able to afford a sizeable deposit, thereby borrowing at less than 100 percent loan-to-value, perhaps at 90 or 80 percent. A lower loan-tovalue provides something of an extra safeguard should home values decline, increasing your chance of being able to trade out of a property should tough financial times hit.

People often ask me "is now the time to buy or not"? That's an i mpossible question t o answer. People don't buy homes purely to maximise financial gain. Most people buy homes because they want a place to live in, and don't necessarily want to wait for years for the market to be exactly right.

Article courtesy of the Weekend Argus