OUR 2015 OUTLOOK IS GOOD, DUE TO OIL, BUT ELECTRICITY SUPPLY REMAINS A LINGERING DOWNSIDE RISK

Starting 2015 we have sketched a healthy outlook for the property market, and why not? We have come in to 2015 with a lot going for us economically. We stand to benefit greatly from the huge oil price drop, and a lesser global food price decline, along with a Rand that performs reasonably well despite our effective "weak Rand strategy" in the form of allowing a huge current account deficit on the balance of payments to persist.

Our resultant forecast is a boost for real economic growth, projected to take Household Real Disposable Income growth up from last year's estimated 1.5%, to 2.8% in 2015, the net result of moderately better GDP (Gross Domestic Product) growth this year as well as a big drop in Consumer Price (CPI) Inflation from around 6% last year to 3.5% this year.

With this expected drop in inflation comes an adjustment in our 2015 interest rate forecasts from rate hiking by the SARB (Reserve Bank) to one of unchanged rates in 2015.

Under such positive conditions, and given the positive mood in the residential market currently, this leads us to expect further growth in residential demand in 2015, and our house price growth forecast is mildly higher than last year's average 7.1%, shifting into the 8-9% range.

As always, though, there are risks to any forecast. We have mentioned two seemingly obvious ones, both home grown, namely our ever present "fragile labour relations", with periodic industrial action proving increasingly disruptive to the economy, and of course the increasing risk of electricity supply disruptions. With the property market being driven largely by economic performance, this all matters.

And with the power-dependent Property Industry being a noticeable contributor to GDP, estimated at 6% of total GDP in 2013, and perhaps nearer to 8% if you add in residential and non-residential construction, electricity supply constraints directly impact its own output and output growth negatively.

THE FUNDAMENTAL PROBLEM OF CONCENTRATION RISK

For many decades, South African has followed a strategy of taking high "Concentration Risk" in the energy sector. By this we mean creating a monopoly model with one dominant supplier, state-owned and protected. Placing the bulk of an industry's production capacity in the hands of any one entity is always a high risk strategy from the outset.

In any industry, from time to time one "player" goes through tough times, and periodically one may even collapse. It has happened in banking, and it has happened to airlines. However, the existence of a number of competitors in an industry means that one player's collapse does not necessarily disrupt the economy in the extreme, as the others can often quickly take on the folded company's clients, and ramp up their production to supply the market.

In addition, humans are known to "lift their game" when competition either exists or even when it merely "threatens". Noticeable in South Africa is that in many industries where a healthy level of competition exists, South African companies operating in such industries can achieve even world class performance. For one, the country's banking sector is frequently highly rated globally, while performances of many (but not all) entities operating in various areas of retail and consumer services seem solid too. Restricting competition too heavily, therefore, also creates a high risk situation.

And so, in our modern economic history, we have exposed ourselves to the risk of big economic disruptions as a result of our highly concentrated electricity sector, the notable periods being around the early-1980s as well as again intermittently since 2008.

A competitive power generation industry model, where competition is well regulated so as to prevent monopolistic power, thus seems in principle the preferred way to go.
Ultimately, it appears likely that the private sector will have to produce a far greater portion of the country's power. But for the time being, "it is what it is", and we have to work around the seemingly growing constraints.

THE POTENTIAL IMPACT POINTS OF THE POWER CRISIS ON RESIDENTIAL PROPERTY

Potential impact on property supply

I have previously pondered the possibility that power supply constraints can be a boost for property values. Insofar as a lack of power supply constrains the level of new property supply, with developers periodically claiming it difficult to obtain the necessarily approvals to develop, some say in part due to lack of ability to secure power supply, it is conceivable that new residential property supply could be limited in part by power supply constraints.

Should this be the case at the current time, when many estate agents are reporting "stock constraints" in the existing home market, this could conceivably be a contributor to higher property prices? Nice perhaps for owners, not so nice for aspirant buyers.

But to what extent a lack of power supply contributes to building sector limitations one can't be sure, and of course there are solar power alternatives to in part get around this. In recent times, actual building activity has been picking up fast it would appear, but how much faster it would perhaps be in the absence of power supply constraints we'll never know. Nevertheless, the residential supply constraining impact of power supply limitations remains one possibility.

Potential impact on property demand

The electricity crisis has the potential to impact on residential demand, too, however.

Firstly, higher electricity costs as a result of the electricity "crisis" imply higher home running costs. This, we believe, is a contributing factor to the shift over the long term towards smaller sized homes, in a bid to reduce operating costs, and thus contributes towards urban densification, which is not necessarily all bad.

Of more concern , however, is that I believe that ultimately the apparently deteriorating power situation is likely to be more to the detriment of residential property as well as the property industry's performance, via the negative impacts on the economy. This is due to its potential to hamper economic and thus household disposable income growth quite significantly, given the electricity supply problem's long term nature.

The power "crisis" can impact on the economy in two key ways:

• The most obvious impact is via the direct impact on industry production each time the power fails. Some businesses can make alternative arrangements to mitigate this risk, but not all can or do, as there are costs involved.(Although I have to admit that my local fast food outlet with its generator doesn't shed too many tears as the crowds descend on it on load shedding nights, so some do benefit)
• Less obvious, but equally important though, is via the impact that erratic power supply can have on sentiment and investment. Why would aspirant energy-consuming investors want to put down their plants or outlets in a country where power supply appears increasingly fragile? The problem has even been highlighted by foreign ratings agencies as a key risk, so it is unlikely that it hasn't already had a negative impact on investor sentiment and thus on future investment and economic growth. Indeed, there has of late been speculation that South Africa's growth potential (Or "Potential GDP" as economists call it) is nearer to 2-2.5% as opposed to earlier estimates of 3-3.5%.

In these times of heightened social tensions, the impact can go further, first hampering economic growth directly, but then indirectly exacerbating the situation when weak economic growth further fuels the social tensions, causing still further economic disruption via industrial action and service delivery protest. At the current time of such heightened tensions, therefore, the negative impact of something as key as power supply can thus be amplified.

Any negative impact on economic growth should normally imply an impact on household income growth and thus on residential purchasing power growth.

Potential impact on both supply and demand via the skills drain

Less obvious perhaps is the potential impact on the "skills" drain out of South Africa. Skilled labour is globally mobile, and the modern way of the world is for some to move country after economic opportunity. Should the electricity crisis fuel a heightened skills emigration rate through a negative impact on sentiment, this would further constrain South Africa's longer term economic growth performance over time, curbing demand for property,while increasing supply somewhat as emigrants sell.

Has the power sector had this impact yet? Tough to say, but it certainly appears to be having a negative impact on certain people's thinking about the economic future of South Africa. What we can also say is that in the thin residential market of early-2008, shortly after the 1st big load shedding "shock" of early that year we did see estate agents reporting a sharp rise in the percentage of residential sellers selling in order to emigrate, peaking as high as 20% in the 3rd quarter of that year.

One can't conclusively pin this all on the load shedding "shock" early that year and its potential impact on sentiment, but the timing of this spike is interesting in this regard, and it is possible that a portion of the skilled echelon of the labour force may well see the troubles in the electricity sector as a strong sign of a general deteriorating trend in the country's economic management. What has perhaps kept the emigration-selling rate low post-2008 has been a global economy with a few subsequent years of high unemployment and more limited economic opportunity for would-be South Africa emigrants. But this can change.

CONCLUSION

Summing it all, the sharp oil price drop of recent months provides key "upside potential" to South Africa's economy and property in 2015. Simultaneously, I would believe that the country's mounting electricity supply constraints, coupled with the huge concentration risk in this strategic sector, currently pose a major downside risk to economic growth, and thus to our forecasts regarding the performance of the property prices, as well as to the performance of Property Sector GDP.

While we have pondered the possibility that a contribution to supply side constraints in the residential market could actually boost property values, ultimately it is difficult to see this potential impact offsetting the potential negative impact that further electricity supply deterioration could have on property demand via the negative impact on economic growth, and thus on employment and household residential purchasing power.

The potential impact of power supply constraints have the potential to be amplified insofar as economic output disruptions come at a time when social tensions are high, and a lack of new job creation can make matters worse in this regard.

Therefore, it would appear somewhat ironic perhaps that both the potential "upside" as well as the "downside" to our economy and property market currently seem to emanate from the word "Energy".