FNB's John Loos says Long Term adaptation to mounting effective urban land scarcity continues

BY JOHN LOOS - AUGUST 15, 2014

Despite around -18.9% real house price decline since the boom period real house price peak at the end of 2007, we remain of the opinion that the residential market remains unrealistically priced in the longer run, with relatively high real house price levels (by our own historic standards) continuing to in part reflect the 2000-2007 economic boom period, and not yet fully reflecting a weak economy battling to average 2% average annual growth since 2008.

The downward “correction” in real house price levels has been temporarily stalled, we believe, by abnormally low interest rates since around 2010, a temporary Reserve Bank (SARB) response to an abnormal global and local economic pressure situation, which in turn provides “abnormal” support to residential property demand.

These abnormally low interest rates have supported gross domestic expenditure in South Africa, but the wide current account deficit that we as a country run is reflective of a country living well beyond its means, domestic expenditure far exceeding national income, and this is not sustainable in the long term.

Recently, the SARB has indicated its intention to slowly “normalise” interest rates, i.e. to hike them probably back up to a level where the policy Repo Rate is positive in real terms (above CPI inflation), which in turn is expected to help curb our dangerous excesses. This we expect to cause the gradual longer term downward real house price “correction” to resume in the coming years.

But market adjustments to longer term home affordability challenges do not happen solely through a real house price decline. They also take place in the form of changes in residential building characteristics, as the residential development sector attempts to keep property affordable through reducing size and streamlining the features.

In our steadily urbanising country, accompanied by increased concentration of economic activity around key urban centres, and along with a slow pace of government infrastructure investment, “effective” land scarcity is mounting over the long term (looking past the property cycles that come and go).

By “effective” land scarcity we mean that, while there is theoretically no shortage of land in SA (with huge rural land areas to exploit), there is a mounting shortage of land located in reasonable proximity to where the economic activity takes place, land with the appropriate level of services and infrastructure required by its owners. Transport infrastructure is key in this regard.

The result of mounting effective land scarcity around urban centres is a long term rise in real property values when measured on a per square metre of per hectare basis as opposed to a per residential unit basis (again, remember, this is looking longer term than the property cycles that come and go).

This long term rise in real property values will not fully be witnessed in the long term real price growth of an average house price index. This is because a house price index measures the value of the average house that gets transacted. And over time, the average house is steadily changing in size and characteristics.

So the market adjusts in 2 ways to deteriorations in affordability. The first has been mentioned, i.e. through periodic real price declines. The 2nd way is being seen in the long run decline in average stand size, in average home size, in a shift to more sectional title, and in less luxuries such as domestic workers’ quarters and swimming pools.

Indeed, if we could construct an average house price index for the past few decades, that could be adjusted for these changes to the characteristics of the “average home” over time, we believe that one would see more of a long term rising trend in real house prices, than has been the case when measuring the average house price regardless of changing characteristics.

The full report takes a look at how these long term changes are unfolding.

Get the full report here.