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Prices are increasing, but this will probably be a short-term phenomenon

(Article by John Loos)

In October 2015, the FNB House Price Index inflation rate continued its mild uptick of recent months, following a prior gradual slowing rate dating back to early-2014.

This may come as something of a surprise in what remains a very weak economy, but may be in part explained by indications of significant constraints in residential supply, which could mean that any slight fluctuation in residential demand could move residential price inflation quite easily.

The FNB House Price Index for October 2015 rose by 7.7 percent year-on-year. This is up from a revised 7.2 percent for September, continuing the mild accelerating price growth trend that has emerged in recent months after a prior gradual slowing trend that started back in early-2014, after house price growth had hit a multi-year high of 8.6 percent at the end of 2013.

In real terms, when adjusting for CPI (Consumer Price Index) inflation, the rate of house price growth accelerated to 2.5 percent year-on-year in September (October CPI data not yet available), with CPI inflation of only 4.6 percent in that month. This September real house price inflation rate was also up on the prior month’s revised 1.9 percent.

The average price of homes transacted in October was R1 043 592

Examining the longer term real house price trend (house prices adjusted for CPI inflation), we see that despite some rise in recent years, (+6.3 percent since the October 2011 low) the average real house price level remains -17.5 percent below the all time high reached in December 2007 at the back end of the residential boom period.

Looking back longer though, the average real price remains 64.6 percent above the July 2000 level, the date when the index started, and a time back just before boom-time price inflation started to accelerate rapidly.

Real house price levels thus remain at “boom time” levels in our view, despite having lost some ground since the end of 2007.

In nominal terms, when not adjusting for CPI inflation, the average house price in October 2015 was 289.2 percent above the July 2000 level.

According to FNB’s valuers as a group, the residential market remains very well balanced, with demand still stronger than supply, so it should not be too surprising to see continued real house price growth from this point of view, despite our expectation that a weak economy should ultimately cause this market balance to deteriorate.

The valuers also appear to suggest that constrained supply is at the heart of sustaining positive real house price growth.

The level of the residential demand rating remains relatively solid at 55.81 on a scale of 0 to 100 in October.

Simultaneously, the valuers as a group rate supply at a lower level of 53.06.

With the supply rating being lower than the demand rating, this translates into a market strength index (MSI) above the crucial 50 level at a 51.3 reading for October. Above a 50 level in market strength implies demand still being stronger than supply in the eyes of FNB’s valuers as a group.

Examining the MSI’s year-on-year growth rates, we see slowing year-on-year growth in the residential demand rating, but negative year-on-year growth in the residential supply rating still translates into positive year-on-year increase in the overall MSI.

However, this does not appear to explain the recent acceleration in real house price growth, because the rate of increase in the market strength index has been slowing of late.

Rather, what seems to be the case is that we may be seeing the lagged impact of a slight acceleration in the year-on-year rate of increase in the MSI back around the second quarter of 2015, before the more recent renewed slowing. Back in the second quarter, demand growth temporarily stopped slowing, and the MSI’s growth rose slightly.

This theory is perhaps supported by examining the month-on-month percentage change (seasonally adjusted) in the FNB House Price Index. This rate often shows short term fluctuations that appear to coincide with movements in certain key high frequency economic indicators, the all-important manufacturing purchasing managers’ index (PMI) being a key one.

A brief surge in the PMI in the second quarter back to above the 50 level( 50 being the dividing line between expansion and contraction), was accompanied by a surge in month-on-month growth in house prices.

So, an apparently briefly better (though far from wonderful) economic period in the second quarter, compared to the economic contraction in the first quarter of 2015, may have briefly turned the residential market slightly stronger, and the lagged (delayed) impact of that may be seen in the more recent rise in year-on-year house price inflation.

The leading indicator for South Africa (OECD version), too, showed a “less negative” year-on-year decline (reaching zero by April 2015) around the second quarter of this year, before turning worse once more in the third quarter.

So, there were some hints of a slightly less negative economic situation around the second quarter, and this may have just been enough to cause a lagged acceleration in house price growth shortly thereafter. The subsequent deterioration in such indicators suggest, however, that it may not last long.

The further mild uptick in average house price growth in the October data may appear somewhat out of place, given many indications of a very weak and broadly stagnating economy.

Certainly, given the multi-year broad deterioration in South Africa’s economic growth, and the likelihood of this deteriorating trend continuing, we would not foresee an uptick in house price growth continuing for any great length of time.

Rather, we believe it could be driven by very short economic fluctuations. It could thus be the result of a slightly and temporarily better economy in the second quarter of 2015, compared to the contraction of the first quarter, coupled with a still-constrained residential supply, feeding though into year-on-year house price growth with a lag.

However, in the third quarter, we saw key up to date indicators such as the manufacturing PMI, as well as the year-on-year rate of change in both the OECD and SARB leading indicators start to deteriorate once more, suggesting that this average house price inflation uptick will probably be short lived.

For the first 10 months of 2015, the average year-on-year house price inflation was 6 percent. Despite the recent months’ strengthening, this remains moderately slower than the 7.1 percent for 2014, and we expect it to remain so when 2015 is complete.

(John Loos is the household and property sector strategist at FNB Home Loans.)


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