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House prices remain subdued as South Africa Inc. stumbles

13 November 2012 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

The largest investment most of your clients make – aside from purchasing an annuity upon retirement – is their primary residence. Although the primary residence is not traditionally viewed as part of a client’s retirement-funding portfolio its impact prio

Savers who are pinning hopes on their primary residence to boost their retirement savings have another hurdle to overcome. House prices – like other investments – tend to rise and fall over time. In the early 2000s you could not go wrong by investing in property. House price growth between 2000 and 2006 was phenomenal... But since the global financial contagion that started in 2007/8 domestic house price growth has been subdued. Over the past three years your clients will have been lucky if their primary residence kept up with inflation. Although experts disagree about both the depth and duration of the current housing market downturn it is not uncommon for such cycles to play out over periods of seven to 15 years!

House price inflation versus economic growth

As proof, consider that the Lightstone Extended House Price Inflation index estimate for national property inflation was just 6.47% for October 2012. The group’s statistics suggest that home owners in Gauteng are slightly better off than those in the rest of the country. They say that the latest yearly house price inflation estimates in the City of Johannesburg, City of Tshwane and Ekurhuleni were 6.97%, 6.63% and 6.33% respectively, while yearly house price inflation estimates in the City of Cape Town, Ethekwini and Nelson Mandela Bay were 4.33%, 5.27 and 5.37% respectively. Geographic differences aside it seems most residential houses are growing at just 1% after inflation… This is certainly not the kind of growth you would look for in a retirement-funding asset.

We wondered whether there was any link between house prices (and prospects for a residential property recovery) and South Africa’s GDP growth outlook. Lightstone provides some of the answers in its assessment of the relationship between house price inflation and economic growth in South African municipalities. “An important topic discussed when analysing any housing market is the relationship between house price inflation and economic growth,” they say. But they quickly add that economic growth is not the only determinant of house price inflation. House price inflation varies with the prevailing long term interest rates, general inflation in the economy and the willingness of banks to grant bonds to applicants, among other factors.

A theory for long-term cycles

The study begins with the premise that economic growth leads to house price growth worldwide. “And in developed countries house price inflation is less sensitive to economic growth than in developing countries,” they say. (We would venture that Lightstone’s observations hold during periods of stable economic growth or decline, but must surely fall to pieces during unnatural housing market slumps such as the sub-prime debacle that has played out in the US since late 2007). How does one measure the relationship between house price inflation and economic growth?

Lightstone explains… Sensitivity to economic growth is defined as the percentage growth in house prices for each percentage of economic growth. For example: South Africa’s total national GDP grew on average by 3.5% per year between 2000 and 2010. House price inflation over the same period was on average 13% per year. A crude measure of estimating the sensitivity of house price inflation is, therefore, the ratio of yearly house price inflation growth and economic growth which is about 3.71 times. It can therefore be stated that a 1% increase in national economic growth leads to a 3.71 times increase in nominal national house prices.

In statistical parlance, the estimated house price inflation sensitivity value is also referred to as elasticity. In the case of the aforementioned example the house price inflation elasticity with respect to economic growth is 3.71. One might object by saying that house prices grew more than 20% during the economic boom in 2005 making the indicator inaccurate. Maybe so, but Lightstone is exploring the long run house price sensitivity to economic growth.

Considering house price inflation elasticity across municipalities...

What follows is a largely academic number-crunching exercise. Lightstone, using its massive database of housing market transactions from a sample of 156 local municipalities, concludes that the house price inflation elasticity in 41% of municipalities is between 3 and 5. In other words, a 1% increase in economic activity in these municipalities results in nominal house price growth of between 3% and 5%. In 18% of municipalities in South Africa a 1% increase in economic activity lad to less than a 3% increase in house prices, while a 1% increase in economic activity led to more than 5% growth in house prices in about 40% of municipalities.

Does their theory hold? The latest forecasts for SA GDP growth are for around 2.5% for 2012… Assuming a ‘middle of the road’ elasticity of between 3 and 5 we should therefore be looking for house price inflation (growth) of between 7.5% and 10% this year… Considering Lightstone’s latest number of 6.47% it seems their assessment, per municipality, is perhaps overstated slightly. The good news for homeowners is that one’s primary residence remains a hedge against inflation over the long-term. The true test will be whether your clients can afford to keep their houses through retirement when the costs of ownership outstrip the increase in the value of the underlying asset.

Editor’s thoughts: There is no doubt that over time the value of your primary residence will grow ahead of inflation. But despite this truth there is a risk that you purchase your home at the beginning of a downturn in property prices – with the result you have negative real growth over a protracted period… How should savers, with assistance from their financial advisers, factor their primary residence into their financial needs analysis? Please add your comment below, or send it to


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