How prevalent is home re-sales price deflation?

| article by John Loos - household and property sector strategist at FNB Home Loans.

While the FNB Average House Price Index has consistently been in a state of mediocre but positive year on year growth since 2009 (although month on month it periodically dips into deflation), this by no means implies the absence of any house price deflation. While it is a minority of properties that are resold for prices lower than what they were previously purchased for, such price deflation on resales is not uncommon.

The causes of such price deflation when reselling can vary:

- Genuine market price deflation can be the cause in weak economic or rising interest rate times, such as in 2008/9, or a specific area can fall from favour and even go into decay.

- A home may have originally been purchased at an incorrectly high price which was above the true market value at the time. Establishing the true market price is tough in a market where each home’s characteristics differs in some way from the next.

- Financial stress of the owner can lead to a deterioration in the property due to lack of maintenance and upkeep, or can cause a very hasty sale at below market value.

Therefore, over an above our usual average house price indices, we extract the data in a different way so as to view it for signs of increasing or decreasing prevalence of price deflation. We use deeds data for properties purchased and sold by individuals (natural persons) for these estimates.

In recent times, the incidence of resales price deflation has been moderate by historic standards, and has shown no meaningful sign of an increase.

Over the last decade-and-a-half, August 2009 was the month where the highest estimated percentage of total properties were being resold at below their previous purchase price since a previous high early in1999, with 23.4% of all property sales registered in that month.

The country had just lived through a recession, and interest rates had peaked in mid-2008, and this was the lagged impact of those economic events on the housing market. It was a period of widespread financial stress among households, and many had previously bought homes at astronomical highs around 2006/7 at the back end of the property bubble.

By comparison, in April 2017 this percentage was a far lower 9.8% of total home sales being below previous purchase price. 7.5% of re-sales were more than 5% below, while 2.2% of sales were 0 to 5% below previous purchase price. These most recent estimates represent no noticeable increase from lowly levels of 2016, with only the August 2016 estimate of 9.4% being lower than the April 2017 estimate in the past 8-and-a-half years.

The relatively low prevalence of resales price deflation is arguably reflective of a relatively low level of financial stress in the housing market in recent times. This implies good average levels of home maintenance, to avert depreciation in many instances, and low levels of hasty financial stress-related selling.

Nevertheless, the insight that this data provides is that even in recent relatively good times, there still exists a significant prevalence of price deflation on a portion of properties. Getting the price right at the original purchase, and buying well within your financial means so as to be able to fully maintain a home, is key to averting resale deflation.

The FNB House Price Index for May 2017 rose by 4.7% year on year. This is a mild acceleration on the revised 4.2% rate of increase for April, and is the fifth consecutive month of accelerating growth since the low of 1.5% year on year reached in December 2016.

In real terms, when adjusting for CPI (Consumer Price Index) inflation, the rate of house price growth remained in negative territory, having recorded a -1.1% year on year decline in April (May CPI data not yet available), albeit a diminished rate of real deflation from the -2.4% rate of the previous month.

This real price decline was largely due to the still-slow nominal house price inflation rate of 4.2% year on year in April, while CPI inflation for than month was 5.3%.

The average price of homes transacted in June was R1 112 466.

Examining house price growth on a month on month seasonally-adjusted basis (a better momentum indicator than the year on year calculation) suggests that a period of renewed economic weakness may once again be emerging after a slightly stronger economic performance in the first quarter of 2017.

The housing market can often be a good leading indicator of economic conditions. Up until March 2017, we saw month on month seasonally-adjusted house price growth accelerate after a late-2016 dip. More recently, in April and May, a renewed month on month house price growth slowing has been accompanied by a significant dip in the manufacturing purchasing managers’ index (PMI) after a rise earlier this year.

The SARB (South African Reserve Bank) Leading Business Cycle Indicator had been rising significantly from August 2016 to February 2017, pointing to likely improvement in near term economic growth.

Mildly improved metals commodity prices made such improvement likely via exports and the mining sector, while the end of drought conditions can boost agriculture production.

But the PMI is a more up to date time series than the SARB Leading Indicator, and manufacturing is normally a good indicator of the broader economy’s direction. The key question at present is how the economy has fared very recently in April and May, following the widely publicised cabinet reshuffle of late-March and subsequent ratings agency downgrades. Renewed slowing in month on month house price growth, along with the sharp April dip in the PMI, is an ominous sign, but more April/May economic data is required before drawing hard conclusions.

From our May FNB House Price Index, we saw some strengthening in year on year house price growth again in that month, although the rate is still moderate and negative in real terms.

However, a better recent momentum indicator for house prices is the month on month seasonally-adjusted measure. After some resurgence up until March, this measure has once more shown slowing growth in April and May, suggesting that any recent market strengthening may have been destined to be short-lived, and a simultaneous drop in the manufacturing PMI in April may explain this renewed slowing by pointing to a renewed short run dip in the economy’s performance.

We note the improved weather conditions and their potential positive impact on agriculture, along with the potential impact of stronger commodity prices on mining. But we are also aware of the dampening impact of recent ratings downgrades, along with an uncertain political and policy environment, on confidence, and this could contain the magnitude of any economic growth improvement.

The FNB forecast is for real economic growth to be only marginally better at 0.7% in 2017, compared to 0.3% in 2016. We don’t expect this to have a material positive impact on the housing market despite apparent mild first quarter improvement. And the recent slowing in month on month house price growth accompanied by a PMI dip convinces us to maintain our lowly 3% average house price growth forecast for 2017 as a whole.

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