What Goes Up Must Come Down

1. Shoe polish and financial implosions

There’s a famous story from Wall Street that goes like this. One afternoon a top broker went out for lunch. On his way back to the office he stopped to get his shoes shined. He soon struck up a conversation with the shoeshine boy, and mentioned that he was a broker.

“Have I got a tip for you!” said the shoeshine boy, and then told the broker all about a sweet, safe deal he’d heard of – big returns, a sure thing. The broker listened politely, paid the man, took the lift back to his 25^th-floor office, and then called every single one of his clients and told them to sell their entire portfolios of stocks immediately. Once he had made sure every one of his clients had cashed out, he sold his own shares. The next day Wall Street plummeted, ultimately triggering the Great Depression. The Dow Jones would only reach pre-1929 levels again in 1954.

This story is probably an urban legend, but it holds an important truth, and one that the wise broker understood: if even the ordinary guy on the pavement is talking about hot stocks, and has his head full of fantasies about easy money, there’s a crash coming, and coming fast.

Why is this relevant?

Go to any dinner-party with teachers, secretaries, mechanics, bartenders, policemen and junior middle-managers – people who have no financial education, who know nothing about economics and who have no way of gauging international financial trends – and the talk is all about property. How much it costs, who it always goes up in value, how to make money from it, and so on.

But the bad news is that all of these people are like that shoe-shiner. All think they have scored, or will score; but the grim reality is that within the next year they could all be crushed by financial burdens that they can’t see coming.

Right now we are at the very top of the biggest boom since 1929. It’s called “The Property Market”. And it is about to come crashing down.

If you don’t believe us, or you think we’re exaggerating, we don’t blame you: the South African media is totally oblivious to this impending tsunami. And if you don’t think it’s going to be as bad as a tsunami, you’re not alone. A recent poll in the United States by the Boston Consulting Group found that a whopping 55% of Americans don’t believe the value of their properties is going to drop – despite the fact that in many parts of the U.S. house prices are already dropping by up to 40%

But the tsunami is real, and despite what you have read in the media or heard from friends, it’s already starting here in South Africa. Even estate agents are talking about a “slowdown”, and in some areas prices have starting dropping.

Perhaps the most effective way of convincing you about the major shock that is coming is to show you graphically.

First of all, check out the Dow Jones Insdustrial Average graph (the U.S. stock exchange) since 1970:

What are we looking at? Well, first there’s the steady but sluggish 1970s and early 1980s, and then slowly there’s an upswing – remember the 80’s of ‘greed is good’ in Wall Street? The Clinton years weather a recession but still there’s forward momentum, until suddenly, around 1995, the US shrugs off the recession. It then goes ballistic just before 2000: the Dot-Com boom. And then it goes pop, with wild swings and a general downward rush. But after a volatile period around 2003, it suddenly goes through the roof, even higher than at the height of the tech boom. That, ladies and gentlemen, is the Credit Bubble and the Property Bubble. Americans have been speculating with credit – building castles in the sky with non-existent money – and now it’s time to pay.

But what about property? Surely any investment in bricks and mortar is “safe as houses”? So what if Wall Street has a hiccup? How can something as abstract and complex as stocks and shares be linked to ordinary people living in ordinary homes?

Well, take a look at this graphic, that appeared recently in the New York Times, and showing the history of American home values since 1890. We think this says it all:

As you can see, the current bubble dwarfs anything before it: not even the famous “boom years” of the 1950s come close to this insane appreciation since 1999. However the most sinister thing on this graph is not the Depression or the slump in World War One. It’s those two little peaks around 1980 and 1990. Those were mini-booms, and each time the prices dropped back to more or less the same level they’d been at since 1950. In other words, when this thing crumbles, and takes the graph back to that level, it will mean massive economic meltdown for tens of millions of Americans who have all their wealth tied up in grossly overpriced houses.

So America is in deep trouble. But how does any of this affect South Africa? And more specifically, how does it affect South African property?

Have you heard the phrase, “When America sneezes, the rest of the world catches cold?” In a nutshell what this means is that when the American economy is healthy, the world’s economy is healthy. When America’s economy slumps, the world follows. And this is especially true for South Africans: we are very closely linked to the US dollar and the fortunes of Wall Street. But thanks to the American property boom, we are now also tied to the fortunes of American property values. The American bubble is bursting right now. From California to Nevada to Florida, homes in all prices ranges are losing value incredibly fast. In mid-August, the slump was around 20% in parts of those states, with no bottom in sight. Foreclosures are at 16-year highs. At the current rate, by early 2008, 1,5 million Americans will have lost their homes. Already U.S. economists are talking recession, even depression. And when that spreads – and it will spread, first to the UK and then to the rest of the world – it will pull the rug out from under our house prices.

A further chilling piece of information kept from you by our media is that South African home prices almost identically mirror American movements: check out a graph of SA's property market over the last 30 years, and you're looking at a carbon copy of the graph above.

The bottom line: American house prices are about to fall by up to 40%, which means that South African house prices are likely to fall by the same.

The flat you just bought for R800,000? It’s going to be worth R480,000.

That house you just bought for R2,5 million? It’s going to be worth R1,5 million.

2. The Great Property Myth: Price Always Go Up

Even if you’ve talked to friends or colleagues about the slowdown in the local market, we bet you’ve heard the oldest line in the book: “Yes, but property always going up. It won’t drop in value – it’ll just flatten out for a while."

Wrong, wrong, wrong, wrong.

Not only can property fall in value, but it can (and often does) fall very far. According to Thomas F. Helbling, in a paper published by the International Monetary Fund, house-price crashes are less rare than the public assumes, and that a fall in prices of around 27% is quite normal. Last year the Economist reported that property prices in Japan have fallen for 14 years in a row – a total drop of 40% since the top of their bubble in 1991.

In other words, a “normal” crash implies an almost-guaranteed drop of 25%, while a monster crash seems to bring with it 40% losses. And considering that we’ve never had a boom like the one just peaking now, the monster crash in store for us could well dwarf those 40% drops. But even if our market just drops a “normal” 25%, can you afford to be caught exposed?

3. South African property is grossly overvalued

How many times in the last year have you heard the following: “Yes, property in South Africa is getting fairly expensive, but really we’re still much cheaper than the UK, and the rise in prices since 1999 is actually just us catching up with the rest of the world."

This is the standard answer to any and every criticism of our ridiculous property prices. And yet it doesn’t answer the one question we should all be asking: why are we talking about British property prices when we live in Africa?

Right now the UK is in the throes of a housing crisis. With house prices skyrocketing, it is now literally impossible for millions of young people in that country to buy a garage, let alone a one-bed flat or their dream home. And yet our local property ‘experts’ have the nerve to tell us to look at the UK market for our answers. Basically they’re telling us, “Yes, the local market is ridiculously expensive, but at least it’s not as ridiculously expensive as the market in the UK.” This is nonsense.

But let’s ignore that for a moment and ask you another question. Why would you pay British prices – or even 50% of British prices – for property in South Africa, a country with 500% more crime than the UK, crumbling urban infrastructure, no functioning public transport, an unstable political future, and a vastly smaller economy?

If you’re still not convinced that South African estate agents, bank economists and politicians are robbing us blind, consider Germany. In Berlin, a world city with fantastic culture, urban energy, superb public transport, and one of the lowest crime rates in the world (you are 44 times more likely to be murdered in South Africa than you are in Germany), you can get the following, all advertised on the internet in August this year:

• 55m² one-bed flat in upmarket central Berlin: R285,0000
• Double-story house, 110 m², on 1600m² plot, on outskirts of Berlin: R340,000
• Two-bed apartment, on tube line in trendy north-east Berlin: R440,000

Yes, you read right. No, there isn’t a typo: we didn’t leave off a zero. R340,000 for a house that would cost at least R2 million in South Africa. In short: you are paying at least 5 times as much for property than people who live in Europe’s biggest economy.

Finally, here’s a piece of information that our media has deliberately kept from you over the last few years (we explain why in a moment). Did you know that in healthy economies, with acceptable inflation and unemployment, the average house price is between 3.5 and 4 times the average annual salary? Do the maths quickly: what’s 4 times your annual salary? Now ask yourself: can you buy anything even vaguely resembling your dream house with this amount?

But if you’re reading this, you’re probably near the upper end of the South African earning scale. According to the last census, the average annual salary for employed people in this country was R49,100. Using the global rule of thumb (and pretending that we don’t have huge unemployment and rising inflation), this means that the average house in South Africa should cost no more than R197,000.

Okay, you say, but that’s a skewed statistic: most employed people in this country work in very badly paid jobs, and can’t afford their own houses anyway. Okay, so let’s look at the top bracket of earners: white males. According the census, the average white male earns R135,600 per year. (This figure is hugely skewed upward, thanks to the top 20,000 white males who average R2,25 million per year). However, let’s pretend that R135,600 is a fair reflection of the highest end of the earning spectrum. This means that the average middle-class house – 3 bedrooms, garage, small garden, etc – should cost no more than R542,000!

Using peoples’ earnings to get a sense of how inflated the property market is also gives us another insight. According to Absa, the average South African home now costs around R900,000. At current rates, this means that if you want to by the average home, with a 90% bond, you need to be earning R25,000 per month. According to the census, there are only 156,000 people in the entire country who earn this much. Even assuming that this number has doubles since 2000, thanks to inflation and the economic boom, that’s still only 0.66% of the population. Be sure of one fact: 0.66% is not enough people to support an industry. The camel’s back is about to break.

4. The Shortage That Isn't a Shortage

One of the favourite lines trotted out by bullish economists and people with a vested interest in property is that South Africa has a massive shortage of housing, which means that there is huge demand, which means that prices will keep going up for years, or even decades.

Of course it’s true that we have a housing shortage. There are million of people who don’t have a roof over their heads, let alone a two-bedroom flat or small house. These properties will have to be built by government or private developers over the next decade.

But it is also a fact that SA’s housing shortage has almost nothing to do with our property market, because the people who need houses will never be in a position to buy even the cheapest place on the market today.

Yes, the black middle class is growing by about 500,000 per year, and all of these people need somewhere to live. But the “Black Diamonds” study that found these numbers also difined “middle class” as people owning a kettle, a microwave and some hire-purchase furniture. In other words, these 500,000 are not all the yuppie, Beemer-driving set that banks would like us to believe. Estimates put the average “Black Diamond” at around R110,000 per year – and amount that would qualify you for a bond of R294,000. Even a young married “middle class” couple, each earning that amount, would only qualify for a bond of R588,000 – well below what even one-bedroom flats cost in the established suburban property markets.

In short, those middle class blacks who could buy a property have already done so (the massive boom since 2000 was definitely contributed to by empowered black buyers); but now that boom is over.

The final nail in the argument that the middle class will continue to fuel the bubble is presented in the ever-growing number of skilled professionals who are emigrating every year: 150,000 per annum at last count. Case closed.

So what does this all this mean for the market in the future? Well, there are various scenarios:

1. The black middle class continues to grow at the expense of the poor, who vastly outnumber them. Social conditions stay as they are now, with growing discontent amongst the poor, and poverty-fuelled crime intensifies. Property remains grossly overvalued because it reflects a non-existent Developed World society and infrastructure, and the increasing pessimism and political volatility accelerates the “Brain Drain”: the middle-class people supporting the property market emigrate, or refuse to commit to owning property because they aren’t sure where they’ll be in 5 years. Prices drop drastically.
2. The wealthiest elite of the black middle class becomes as obsessed with owning rental property as the white middle class currently is. Builders cater for these twin obsessions, and within a decade there are hundreds of thousands of second homes. Supply outstrips rental demand, as the poor will stay poor, and unable to rent these properties. This has happened in many cities in the US. Empty houses equals slumping prices.
3. The state recognizes that there is a serious problem with affordability, and begins to legislate against unrestricted price growth. Second homes are heavily taxed, bonds on second homes come with viciously high interest, etc. It becomes a financial burden to own more than one property, and thanks to the glut of complexes and developments suddenly for sale, prices plummet.
4. The state doesn’t legislate, but instead launches a massive building programme that puts up 3 million low-cost houses in a decade. High supply drops demand, and prices drop too

In short, there is no long-term scenario in South Africa in which prices increase.

A final word on the shortage that isn’t a shortage. One of the biggest drivers of a property crash is oversupply. Greedy developers in the US built hundreds of thousands of units in the early 2000s, and right now all across the US, there are hundreds of thousands of units standing empty. The same is about to happen in South Africa, albeit on a smaller scale. Despite daily reports of cooling markets – and of the first prices starting to fall – tens of thousands of units are still being built. The Cape west coast is already a ghost town, as ambitious complexes and estates stand empty. Nobody is touching Parklands with a ten foot pole, with the result that entire blocks, with dozens of large houses with gardens, are deserted. And yet still they build. In Tygerberg alone developers are currently putting the finishing touches on a development that will boast 1,000 luxury apartments. This while Remax’s website sports 3,000 unsold homes in Cape Town. That’s a ghost town in the making.

5. How The Bubble Bursts

1. Prices start leveling off, and dropping in places. This has started happening in parts of South Africa. You wonder whether you should sell your second home or rental flat. Potential buyers now smell trouble, and put away their chequebooks
2. At the same time, the National Credit Act radically cuts down on the number of people eligible for bonds. The pool of potential buyers shrinks even more
3. You decide to sell, to avoid trouble. But your neighbours are also selling, and they’re selling for R50,000 less than what you’re asking. You are forced to drop your price to compete
4. The buyers see prices dropping everywhere. There is now almost no chance they will buy while they can wait for a better deal
5. You realize there is a major problem, and many other owners start panicking. They drop prices by 100,000. You are forced to do the same
6. Only once buyers think that the market has bottomed out do they begin making offers, and prices stabilize. How down it’s gone before that happens is anyone’s guess, but as we’ve shown here, you must bank on 25%, and be ready for 40%

6. Negative Equity and How It Will Kill You

This is simple maths, and reflects the nightmare that is coming to South Africa. It is happening right now in thousands of suburbs of the United States, and it looks like this:

• You buy a flat for R800,000, with a R600,000 bond
• The bubble bursts, and you try to sell, but nobody is buying
• Your property is now worth R560,000 (and once estate agents have taken their pound of flesh, it’s worth only R530,000). But you still owe R600,000 on your bond
• Not only are you now technically bankrupt, but you also owe R70,000 that you have no way of paying back, because you’re already paying the maximum monthly installment that you can afford
• You are financially ruined, and your life changes forever

7. Why You Don't Know Any Of This

If all of this is news to you, don’t feel bad. There is almost no reason why you should have heard of the impending market crash in South Africa. Not only is our news dominated by crime and politics (at the expense of everything else), but there are forces actively at work to suppress any and all bad news about property.

It is a well-known fact that reporting on property in our newspapers and internet sites is heavily biased in favour of good news. The reason for this is old fashioned laziness: senior reporters don’t do the property beat (being too busy with high finance issues), so these sections or pages are almost always left to junior interns or bored staffers who are too lazy or incompetent to do anything except print press-releases verbatim. And where do these press-released come from? Estate agents, loan originators, and banks. Surprise, surprise...

Just log onto News24.com, one of SA’s biggest and most popular sources of news, and click on the Property section to see what we mean. We can guarantee that 60 – 70 percent of the stories posted will be “Huge demand for x” or “Still room to make a killing in y”. This is not news. This is advertising for estate agents and developers, planted in our incompetent, uncritical media, to make you buy.

If this sounds like a nutty conspiracy theory, then ask yourself this: when you read property news, and they quote authority figures or people clued up about the current market, who are they talking to?

We’ll tell you who they’re talking to: the only people ever quoted in the media when it comes to property are bank economists (John Loos is a favourite of the local media, despite the fact that he has made over ten different predictions in the last eight months), or else the CEOs of estate agencies.

Now ask yourself this: is a bank economist, whose enormous salary is paid by your bond, really going to tell you not to apply for a bond or buy a property? Is Pam Golding really going to tell you that they house she’s selling you for R5 million is actually worth R3,5 million? And is the otherwise independent Mail&Guardian going to run articles telling you the truth when every week it encloses a large-format glossy sales brochure for Pam Golding Properties?

We thought not...

Read the media with a critical eye, and you’ll soon see that almost every piece of news about property is like the quote by a famous American general, who was asked by reporters why he was retreating. “Retreating?” he said. “We’re not retreating. We’re advancing in reverse!"

8. What You Can Do To Dodge The Bullet

• Sell now. If you’re 50/50, sell tomorrow. If you’re pretty comfortable, think hard about the future, and then sell next week
• Sell privately. Estate agents are parasites, and are actively spreading misinformation to inflate prices and deny that a crash is coming
• Do not, under any circumstances, buy property until the end of 2008, and only then see what the landscape looks like. Property is going to be a financial bloodbath
• Once you’ve sold, move into your rental, put your feet up, and watch the agents, developers, and greedy owners burn

9. If You're Under 30

• Understand that as things stand currently, you are never going to own your own home
• The worst possible mistake you can make now is to try to “get onto the property ladder” because you feel that you’re being left behind. In the current market this is a one-way ticket to financial suicide
• Not only do you need to wait for the crash to happen, but you need to actively encourage it to happen: tell your friends to wait before buying, spread the word on campus, at the office, wherever. Copy this pamphlet and hand it out. Start a blog, or just put this pamphlet online. The sooner the crash happens, and the further prices fall, the better off you’ll be in the long term

10. Why We Produced This

The bust is very real, and it’s going to happen soon. You aren’t going to hear about any of it in the mainstream media before it breaks, and so as concerned independent economists we felt we had to counter the massive pro-property propaganda wave currently saturating the media. We are both parents with teenaged children who are never going to be able to afford their own home if things continue like this. We need to take back the power from estate agents and banks. They need to serve us, not the other way around.

Good luck in the next 18 months. The propaganda is going to get vicious, and it will be difficult to figure out the difference between the truth and lies. Hang tough. Don't let your ignorant friends sway you. And always remember: what goes up, must come down. Not all the way down, of course - but 40% is a long way, and a good start.