Economic Perspective Residential Property Market

House prices in the third quarter of 2006

House prices in the middle segment of the market increased by a nominal 13,8% y/y to about R818 300 in the third quarter of 2006 compared with the 14,7% y/y recorded in the second quarter. The 13,8% y/y increase was the lowest nominal growth in any quarter since the first quarter of 2002, when a growth rate of 13,7% was recorded. In real terms, house price growth came to 7,9% y/y in the third quarter (the lowest real growth since the first quarter of 2003) compared with 10,3% in the second quarter of the year.

In the three middle-segment categories, house price growth was as follows in the third quarter of 2006:

• Small houses (80m-140m): a nominal 15,1% and a real 9,1% higher.
• Medium houses (141m-220m): a nominal 16,1% and a real 10,8% higher.
• Large houses (221m-400m): a nominal 11,0% and a real 5,3% higher.

In the category for small houses, year-on-year nominal price growth bottomed at 13,9% in the fourth quarter of 2005 and increased to 15,4% and 16,7% respectively in the first and second quarters of 2006. This could be ascribed to housing, in general, becoming less affordable in recent years, shifting the focus to smaller properties. However, in the third quarter, year-on-year growth in the prices of small houses was down to 15,1%. This might be a reflection of the impact of higher interest rates since June this year.

The year-on-year price growth of medium-sized houses levelled out at just above 16% in the first three quarters of 2006, with the focus probably shifting from larger, more luxurious properties in view of the issue of the affordability of housing in general. During the next few quarters, price growth in the medium-sized segment will be closely watched for any signs of weakening on the back of higher interest rates, such as that with regard to smaller houses in the third quarter.

Building costs and new and existing house price trends

The cost of building a new house increased by a nominal 10,3% y/y in the third quarter of 2006, compared with a growth rate of 10,5% y/y in the preceding quarter. This above-inflation increase in building costs is a reflection of the level of activity in the building and construction sector. The demand for building materials and skilled labour has also contributed to this development.

However, the nominal year-on-year growth in building costs continued its downward trend, which commenced in the third quarter of 2004, up until the third quarter of 2006. This can be ascribed to the large number of developers and building contractors active in the property market, which leads to greater competition. The slowing down of the residential market since late 2004 also played a role.

The average price of a new house increased by a nominal 11,6% y/y to about R832 900 in the third quarter of 2006, which meant an increase of 5,9% y/y in real terms. The average price of an existing house increased by a nominal 14,9% y/y to about R820 200 in the third quarter, which brought the real price increase to 9,0% y/y.

The nominal price difference between new and existing houses was stable at 1,5%, or just more than R12 000, during the first three quarters of 2006. This is the smallest price difference recorded since mid-1989. The price difference between new and existing houses has declined sharply since mid-2003, when it reached an all-time high of R173 200, or 31,2%.

Mortgage finance

Commercial banks variable mortgage interest rates increased by 50 basis points in both August and October to reach 12% after the Reserve Banks Monetary Policy Committee hiked the repo rate to 8,5% at its October meeting. Interest rates have been on an upward trend since June this year.

Based on an average house price of R818 333 in the middle segment of the market in the third quarter of 2006, the monthly repayment on a new mortgage (100% over a 20-year repayment period at a variable mortgage rate averaging 11,3%) amounted to R8 633. In the same quarter of last year, the comparable repayment was R7 180, calculated at an average house price of R719 159 and an average mortgage rate of 10,5% at the time. The difference of R1 453 between these monthly repayments can be ascribed to house prices being 13,8% higher in the past quarter than they were a year ago, whereas the mortgage rate was on average 80 basis points higher than in the third quarter of 2005.

Affordability of housing

Based on interest rate and house price trends in the third quarter of 2006, the average mortgage repayment and the qualifying gross income levels were 20,2% up on the same quarter last year. In the third quarter of 2005, this growth rate was still at 15,5%.

The house price-to-remuneration ratio tapered off somewhat in the first quarter of 2006 (the most recently data available for remuneration) from the preceding quarter. This was the net result of house price growth slowing to 16,4% y/y at the time, whereas nominal growth in remuneration was 7,3% in the first quarter of 2006 compared with 4,4% in the fourth quarter of last year.

The mortgage repayment-to-remuneration ratio, which can also be regarded as an indication of the affordability of mortgage debt, also declined slightly in the first quarter of the year. This development in the mortgage repayment-to- remuneration ratio can be ascribed to slower-growing house prices and low interest rates over the past twelve months, whereas growth in remuneration remained relatively strong.

The decline in the abovementioned two ratios from the final quarter of 2005 to the first quarter this year implies that the gap between house price growth and mortgage repayments, on the one hand, and remuneration, on the other, has narrowed. This means that housing was, in effect, slightly more affordable in the first quarter of the year compared with the fourth quarter of last year. Future trends in these two affordability ratios will depend on developments with regard to house prices, interest rates and remuneration.

Outlook

CPIX inflation increased further in the third quarter of the year on the back of volatile international oil prices, a weaker rand exchange rate, and higher food price inflation. CPIX inflation is projected to rise further to above 6% by year-end. The deficit on the current account of the balance of payments remained above 6% of GDP in the second quarter of 2006, which contributed to the rand depreciating significantly against the major international currencies in recent times. Year-on-year private sector credit extension remained high, with mortgage advances growth at around 30% over the past few months compared with a year ago.

Against this background, interest rates are forecast to rise further, by 50 basis points at each of the Monetary Policy Committee meetings in December this year, and in February and April next year. This will bring the prime interest rate and the variable mortgage interest rate to 12,5% at year-end and 13,5% by mid-2007.

As a result of these expectations, house prices are projected to increase by 13,7% y/y in nominal terms in 2006, taking into account the price growth of 14,9% on average recorded in the first three quarters of the year. Nominal house price growth of 5,9% is expected for 2007, with prices declining by 1,9% in real terms next year. This will be the first real decline in house prices since 1999.

Courtesy ABSA Bank