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No burst bubble

10 November 2004 Angelo Coppola

The SA residential property market has performed particularly strongly in the past few years, with a nominal year-on-year increase of 17,4% in house prices in 2000, followed by further increases of 14,1% in 2001, 15,1% in 2002, 21,5% in 2003 and 31,6% in

These strong house price increases since the end of the nineties have caused increasing concern that South African residential property is currently overvalued and fears that the market is experiencing bubble conditions, as is alleged to be the case in many other countries.

Indicators such as the house price-to-income ratio, the mortgage repayment-to-income ratio and the price difference between new and existing houses are still not at the levels reached in the early eighties, when there was also a strong property market boom.

Furthermore, a wide range of fundamentals supporting the market can be identified, many of which were absent at that time. Some of these factors will probably continue to support the property market in the foreseeable future.

In the light of these indicators and supporting factors, the South African residential property market is considered to be in a strong rising phase, rather than experiencing bubble conditions.

House price developments in the third quarter of 2004

The average price of houses in the 80 m2-400 m2 category and priced up to R2,2 million (the previous cut-off point was R1,6 million) rose by 34,5% y/y in the third quarter of 2004.

This brought the average price of a house in this category to about R594 500 in the third quarter of 2004.

In real terms, this year’s third quarter house prices rose by 32,7% y/y, taking into account an average consumer price inflation rate of 1,3% during this period. This brought the real house price to about R475 500 (at constant 2000 prices) during the past quarter.

In the first three quarters of 2004, house prices have already risen by more than 30% y/y in both nominal and real terms. Although various factors have offered support to the housing market of late, low interest rates probably remain one of the most important factors contributing to the sustained strong price performance during this period.

Building costs and price trends with regard to new and existing houses

In the third quarter of 2004, the average increase in the cost of building a new house compared with a year ago was 16,5%. In the light of this, the average price of a new house amounted to about R681 500 in the past quarter, a nominal 15,2% and a real 13,7% higher than in the corresponding quarter last year.

The average price of an existing house was about R575 700 in the third quarter of this year (a nominal 36% and a real 34,3% up on the same quarter last year).

This made it, on average, about R105 800 or 15,5% cheaper to buy an existing house than to build a new one.

The price difference between new and existing houses has been showing a declining trend since the first quarter of 2003, when it reached a record high of 31,5%.

Prospects

Any so-called local residential property market bubble, should it exist, is unlikely to burst spontaneously.

A sharp downward adjustment in property prices is only likely to result if there is a macro-economic shock such as an exchange rate crisis or a considerably higher international oil price, which would lead to significantly higher inflation and interest rates in the short term. Such macro-economic shocks are not currently factored into Absa’s baseline projections.

The strong growth in house prices of more than 30% y/y during the past nine months is not expected to continue unabated. Quarter-on-quarter house price growth has declined since the first quarter of 2004, which sets the scene for lower y/y growth in the near future.

With interest rates currently near their bottom turning point, stable rates, and especially higher future rates, combined with still rising house prices, will result in higher mortgage repayments.

This will have a negative effect on the affordability of housing, which will eventually lead to lower growth in house prices.

Quick Polls

QUESTION

As National Treasury mulls a two-bucket retirement system, mandatory contributions and preservation, regulation 28 is being amended to allow up to 40% of retirement fund assets to be invested in SA-based infrastructure… Which of the following retirement fund ‘tweaks’ would you consider most beneficial to your clients?

ANSWER

Give fund members emergency access to retirement savings
Let fund members invest 40% in infrastructure
Let fund members invest 40% offshore
Mandatory preservation when resigning from a fund
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