John Loos of FNB Property Finance looks at the potential impact on the residential property market of the National Credit Act.
The National Credit Act (NCA) has got the tongues in the residential property
market wagging, and in some quarters, has caused some alarm.
It is too early to quantify the "damage" done by the Act, but the reports
emanating from household-related lenders do indicate a significant impact. It is
important not to over-react, however, as much of the impact may be temporary in
nature due to "teething problems" related to the change in the way that lenders
are forced to do business.
Firstly, let's accept that there has probably been a significant slowdown in
mortgage loan approvals during June. But what still needs to be determined is
the various factors causing the slowdown.
One should assume that the administrative process required by the NCA has become
more cumbersome, and therefore perhaps longer in many instances. This effect
would be a "once off", and would rectify itself in the monthly volumes after a
few months once the delay has become a "permanent feature" of the mortgage
application and approval process.
Another factor would be clients having yet to fully adapt to new requirements
placed on them in terms of information required regarding their financial
situation. In cases where clients get turned away due to insufficient
information, it could often merely be a case of "back to the drawing board" for
many, before returning later with the required information. In such cases the
negative impact on property transaction volumes need also not be permanent.
Then there is the case of mortgage loan applicants whose applications get
rejected due to the affordability calculation indicating that they do not have
the capacity to repay their debt. This is the crux of the NCA, as it aims to
prevent so-called "reckless lending". Some alarmists seem to imply that such
applicants who do not qualify for the loan for which they apply are lost to the
residential property market forever. This is not necessarily the case. Many of
the applicants will merely have to moderate their expectations, look for a more
affordable house, and apply for a smaller mortgage loan. Others would be able to
go home, re-prioritise their finances, reduce certain other non-property
expenditure items (similar to what many of us do subsequent to taking on more
debt except that the NCA may now require them to do it in advance of increased
borrowing), and come back some months later in a better financial state to
qualify for the desired mortgage loan.
In addition, when applicants are turned away, they may choose to re-prioritise
their debt too. Here, I believe that residential property has a potential
advantage over other forms of shorter term debt. A house is an asset, besides
being a necessary item for the average middle class household, and is seen by
many as more of an investment than many consumer goods which are purchased on
credit. When faced with the need to re-prioritise debt, many households could
try to dispense with some less essential forms of short term debt first. I
believe, therefore, that mortgage debt has a possible advantage over other forms
of credit due to the popularity (and perceived necessity) of owning residential
property.
This choice in favour of residential property-related debt may further be
enhanced by the fact that mortgage debt is repaid over a longer term than, for
instance, credit card debt, and normally has a lower interest rate. This makes
the monthly repayments more affordable, and it would thus make some sense, where
affordability of debt-repayment becomes an issue, to rather cut back on the
short term forms of credit.
Even the household that falls badly short of the new NCA credit requirements is
not necessarily lost to the residential property market. That household could go
for the rental option, more affordable in the short term than credit buying in
many areas because of the low yields that currently exist. This would be an
additional boost for rental demand, which in turn would ultimately provide
additional support for the buy-to-let market.
Therefore, while there are currently many concerns regarding the impact of the
NCA, and many uncertainties too, I would suggest that much of the apparent
impact that we currently experience will be temporary, and will be watered down
over time as both lenders and borrowers adjust to a new way of doing business.
In addition to all of this, it may be difficult to separate the impact of the
NCA on the market from all the other negatives currently present, including
another interest rate hike in June along with deeds office disruptions due to
June civil service strike actions.
That there will be some form of impact I would not dispute, but I do not expect
it to be severe. Let me sum up the anticipated impacts below:
- No impact on the main trends currently experienced in the residential market.
We know that the residential market has been on a slowing trend (in terms of
house price inflation), and that trend is expected to continue into next year
before turning for the better. The end of aggressive interest rate reduction
after 2003 started this broad slowdown as from late-2004, and more recently the
interest rate hikes have sustained this. The NCA may perhaps just exacerbate the
weakening trend a little in the near term.
- There has been a relative shift in activity towards the lower end of the
residential market, with more affordable areas outperforming the more
illustrious areas in terms of price inflation. Once again, the NCA will probably
add to this trend, as certain borrowers have to moderate their expectations,
take on smaller value loans than previously applied for, and go for more
affordable areas.
- As mentioned, the NCA may lead to some additional rental demand from those
people who were turned away at the bank but who desire to sustain the living
standard aspired to. Again, though, this won't lead to a trend change, as
Trafalgar has already reported the beginnings of a rental market recovery from
late-2006.
- From the additional support for the rental market, flows the belief that there
could be additional support for the buy-to-let market. This market has been
weakening for some time. My expectation has been that it will turn for the
better at some stage in 2008 on the back of further significant recovery in the
rental market. The NCA may just help to bring the recovery of the buy-to-let
market forward from when it otherwise may have been, due to a rental market
growing at a slightly faster pace than otherwise would have been the case.
All in all, therefore, I do not expect any major trend changes in residential
property as a result of the NCA, merely some slight re-enforcement of current
trends in the short term. My gut feel, too, is that many of the problems
recorded are more "teething problems", and as such temporary. Admittedly only
time will tell.In addition, if the NCA is going to be successful in eliminating reckless
lending and promoting more responsible lending, this will be to the long term
benefit of the residential property market, promoting sustainability in
performance. There has been much written regarding the dubious activities of
lenders in the ailing US sub-prime residential market. Healthy and responsible
lending practices are a positive for residential property performance in the
long term, not a negative.
Having said this, though, my feeling is that on average, lending practices in
SA have not been reckless. The household debt-service ratio for the country as a
whole is still not at historic highs, and while certain household-related bad
debts have risen with the interest rate cycle in recent times, the banks are not
experiencing a crisis. This would suggest that the adjustments that lenders
(there are always some reckless ones but I'm referring to the group as a whole)
need to make to curb reckless lending and get in line with the NCA are not
extreme and as such the impact should be limited once the new modus operandi has
been established.
Therefore, I expect that in a year's time or so, we'll look back on the NCA
implementation as a minor "irritation", and the residential property market will
be doing just fine. Because at the end of the day, when the Clinton Democrats
used to roll out their campaign slogan "It's the Economy Stupid", they could
just as well have been referring to what is by far the biggest driving force of
the South African property market. At around 5% per annum real economic growth,
the important long term property fundamentals still look solid.
