Thursday, 17 February 2011

The Slow Affordability adjustment continues

As the residential market stays on the weaker side of the economic spectrum.

The FNB Quarterly Housing Review focuses on the key issue of housing affordability, and why residential demand has not grown significantly despite a very significant improvement in the two "traditional" calculations of affordability that are used.

These measures are the average house price/average remuneration ratio and the installment value on a 100% loan on an average priced house/average remuneration ratio. Both of the indices reflecting these ratios have fallen (improved) dramatically since their peaks in 2007/8, the price/average remuneration ratio by -22% and the installment/average remuneration ratio by -40.4%, with interest rates providing additional downward impetus for the latter ratio.

However, these dramatically improved trends run contradictory to our FNB Estate Agent Survey results where an increasing percentage of agents (57% by the 4th quarter of 2010) are stating that income levels have got "far behind home price levels". Despite the estate agent survey question requiring only a subjective and qualitative answer, our feeling is that their answer is far closer to the mark than calculations using average price and average remuneration.

This is in part because of the major decline in formal sector employment from 2008-early-2010, according to the SARB as much as -15.4% over the period. Therefore, the average income earner may be fine, but formal income earners are significantly less in number compared with a few years ago.

However, the issue is more complex than that, because the question has arisen as to how come the likes of new motor vehicle growth far outstrips new home sales (and thus new residential building activity growth)? The motor vehicle sector operates in the same economy as the home market, and is also affected by issues such as recession and job loss. But new motor vehicle sales growth was robust through 2010 to early-2011 (as were retail sales), while the also interest rate-driven new housing demand (and thus building activity) remains virtually in freefall.

Here, the concept of "relative affordability" comes into play to partly explain the differing performances. During the last decade, prior to the recession, both the housing market and the vehicle market had huge demand booms, driven largely by a dramatic reduction in the cost of credit, a healthy economic and household income growth rate, and a far lower household sector level of indebtedness than today.

However, the boom time rate of increase in house prices far outstripped that of vehicle sales due to a far greater limit in the supply of new homes to the market. The more severe supply constraint in the housing market is due to building sector constraints, whereas vehicles can be imported rapidly rendering the supply thereof virtually unlimited for a small economy such as our own.

The result was that house affordability (price relative to income/remuneration) deteriorated far worse during the boom than was the case for motor vehicles, with vehicle affordability actually improving over the whole decade. This relative affordability deterioration in housing alone must surely have an impact on the relative performances of housing demand versus vehicle demand.

However, the possible reasons go even further. While many people think of home ownership as an essential item, the reality is that for the middle class it is not always essential in the short term. Or, at least, it is not always as essential as vehicles. By this we mean that would-be new entrants to the home market can often rent, or alternatively, delay their entry into property by remaining in their parents home for longer than perhaps originally planned.

Mobility, however, is extremely important in the middle to upper income job market, and good public transport is not yet a reality. Private vehicles are thus arguably a more essential middle class item than owning a home.

Motor vehicles also have a shorter lifecycle than houses, meaning a shorter time to replacement. Therefore, one would expect this, too, to cause a more prompt recovery in vehicle demand once economic conditions improve or interest rates fall.

Back to affordability issues, and one must not rule out the impact of rates and utilities tariffs related to housing. These have climbed steeply in recent times, and the multi-year Eskom tariff hikes mean more of the same in 2011 and 2012, outstripping private vehicle related cost increases. Electricity tariff hikes are most prominent in this regard, but assessment rates and water are not far behind.

Finally, with regard to access to finance, it probably wouldn't even be necessary for home loans banks to have tighter credit criteria than vehicle financiers in order to have a bigger negative impact on their market. The large value of a home purchase relative to car purchases (on average) mean that a 10% hypothetical deposit on a motor vehicle purchase would be manageable for more people than a 10% deposit on a house.

Therefore, SA's severe lack of savings militates far more against a big ticket item such as a home purchase than against items where smaller loans are required.

So, the affordability deterioration of housing relative to both vehicles and overall consumer goods and services (including the relative affordability deterioration contribution of big rates and tariff hikes), over the last decade as a whole, should imply the need for the household sector to re-balance its expenditure basket by reducing the portion spent on housing relative to other items. Many would-be new entrants can do this in the short term, due to the less essential nature of middle class home ownership relative to reliable motor vehicles.

Hence, the ongoing decline in new residential building completions in 2010 in stark contrast to sharp growth in new motor vehicle sales. This re-balancing of the household sector expenditure portfolio, along with very weak job creation further hampering new entries to a market that still appears to be oversupplied, and given our expectation of no further interest rate cuts in 2011, leads us to the expectation of mild average house price deflation in 2011. We pencil in an FNB House Price Index decline of around -1%.

While there are no obvious indications of any significant stimulus for the market in 2011, at this stage there are fortunately no obvious indications of any sharp shock to the market either, just a very "flat" and unexciting year. Any "unexpected" shocks to upset the apple cart would probably emanate from foreign sources.

What happens to the US economy after their huge stimulus measures wear off? Do capital inflows into SA reverse sharply, causing a sharp currency weakening and an inflation surge? Do global food and oil prices "spike" again? For the time being, though, the 2011 environment appears fairly benign, but with gradually increasing upward pressure on inflation, which in turn is expected to lead to interest rate hikes from early 2012.

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