Housing prices show return to normality: Part 1

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Normal, in the sense that as most houses age, they lose value as wear and tear and changing fashions take their toll. In the US, this rate of house depreciation is found to average 1% annually.

South African housing stock, meaning Western style housing usually larger than 80 m2 but excluding low-income housing and houses in townships, are found to have many similarities with US housing.

Our post-WW2 housing stock today is on average estimated to be 25-30 years old, a rough rule of thumb suggesting that existing houses should on average reflect a 25%-30% discount to newly built houses.

Four years after the last property market peak, this relationship has effectively been re-established once again, according to Erwin Rode.

Relative to reported new building costs average existing houses can currently be bought at a 25% discount.

If a new house costs R100 to build, its existing 25-year old equivalent is currently priced at R75 on average. This suggests that relative normal value has been re-established.

Future predictions

Looking ahead, we note two likely developments, regarding building cost inflation and nominal house prices of existing homes, effectively a continuation for the time being of the recent past.

Replacement costs have four components, namely the builder's profit margin (currently severely suppressed), the cost of building materials (which is driven higher by, inter alia, energy costs), the cost of labour and the cost of serviced land.

Builder's profit margins cannot be suppressed further, given how much they have already been squeezed. Indeed, the only way is for them to increase again once normality is restored.

The energy costs going into the making of building materials (diesel, petrol, electricity) are rising in a rapid tempo, guaranteeing that building costs will keep climbing rapidly in coming years.

Labour costs don't rise as fast when hard times hit the building industry, but they do keep increasing.

Adding up these three cost components and, for the moment, ignoring the cost of serviced land, the rise in building costs is going to remain a reality.

At the same time, quite independently, we need to look at the demand and supply of existing houses.

Here the expectation is that nominal house prices will only rise minimally for some years still, at low single-digit (0-5%) annually.

Oversupply of houses

The reason for the minimal gain in nominal house prices is a substantial supply of existing houses wanting to be sold but not being matched by enough buyers coming forward and bidding house prices higher, with existing houses being worth only as much as what a willing buyer is prepared to pay (a very old home truth).

The reason for this mismatch may have various explanations.

For instance, the number of willing buyers may have shrunk temporarily as appetite for property purchases may have suffered, given the events of recent years (due to a sense of being over indebted, perceptions of falling house values, a new sense of priorities).

Such sentiments are difficult to measure. More obvious is the apparent difficulty of willing buyers to raise finance, with the ability to do so in many instances having become constrained for the time being.

The reason for this 'funding shortfall' is not only the National Credit Act, but also because credit providers have adopted a new credit culture after the searing experiences worldwide and here at home since 2007.

Instead of 'easily' making mortgage funding available, as had been the case for a generation, old disciplines have been rediscovered and reapplied. Most home mortgage borrowers are expected to maintain conservative debt loads, have stable sources of income, have sufficient income to meet all eventualities and can provide some equity as part of the property purchase while also financing all attendant costs of acquiring a new home.

This proto-type 'new-model mortgage borrower', today probably still the exception, will take time becoming the norm, possibly a decade when counting from 2007.

In the interim, though, many potential homebuyers and borrowers still carry too much debt, have too little savings yet, may not earn enough to satisfy the credit providers and may not have stable enough income (when considering bonuses, options, piecework, commission, fee income, own business income, dividend income, rental income and other volatile types of income).

Only when this large pool of potential homebuyers and borrowers has changed enough to be recognised as being 'new model' would we expect to see faster mortgage lending and a resurgence in housing demand that might start to match existing supply and allow nominal house prices to rise faster again.

This may be accompanied by a psychological shift in appetite as well, recuperating once again as it has always done in the past, though there are exceptions (such as Germany and Japan in the post-WW2 period).

In the second and final part of this series, we will discuss the main implications, options, cost of serviced land and the slow process.