Residential Property Market - Second Quarter 2007

Macroeconomic and household sector overview

The South African economy has recorded growth of 5% per annum in real terms over the past three years. This level of growth was last seen in the late 1970s and early 1980s, and was largely driven by buoyant domestic expenditure, high commodity prices and good world economic growth.

In the fourth quarter of 2006, the ratio of household debt to disposable income increased further to a record high of 73,8%. This was the result of continued high growth in private sector credit extension on the back of low interest rates and strong consumer demand. The higher debt-toincome ratio, together with the upward trend in interest rates in the second half of last year, caused the cost of servicing household debt to increase to 9% of disposable income in the fourth quarter. However, this was still well below the level of 14,5% recorded in late 1998.

The real disposable income of households increased at a seasonally adjusted annualised rate of more than 7% in each of the last three quarters of 2006. This strong growth in disposable income occurred despite inflation increasing in the second half of the year, mainly because of the high level of real economic growth and substantial tax relief at the beginning of last year.

The ratio of net household saving to disposable income deteriorated further during the course of last year, declining from -0,1% in the first quarter to -0,7% in the fourth quarter. Last years growth of 7,3% in real household consumption expenditure contributed to the net saving ratio of South African households turning negative for the first time in history in 2006.

The following macroeconomic and household sector related developments occurred in the first few months of 2007:

• The 2007/08 Budget: Personal tax relief amounting to R8,9 million was announced; the tax-free limits for interest and dividend income were marginally increased; tax on retirement funds was abolished; no changes to transfer duty on property were announced; and the monetary thresholds with regard to estate duty, donations and capital gains tax were increased.
• Domestic fuel prices have increased significantly since March in response to volatility in international oil prices and the rand exchange rate.
• Inflation is under renewed upward pressure as a result of sharply higher fuel prices, whereas food price inflation is starting to show the effects of the severe drought conditions which have been experienced in recent months.
• The Reserve Banks Monetary Policy Committee kept the key monetary policy interest rate, the repo rate, unchanged at its February and April 2007 meetings. As a result, commercial banks lending rates (the prime overdraft rate and the mortgage rate) were also left unchanged.
• Growth in domestic private sector credit extension, especially mortgage advances, remained high.

House prices in the first quarter of 2007

Affordable housing

In the first quarter of 2007, nominal house prices in the affordable segment (houses of 40m-79m and priced at R370 000 or less) increased by 18,1% year-on-year (y/y) to about R243 000 on average. In the fourth quarter of 2006, the nominal price rise was 15,7% y/y. In real terms, house price growth in the affordable category came to 11,8% y/y in the first quarter of this year, compared with growth of 9,6% y/y in the final quarter of 2006.

The current rising trend in the price growth of affordable housing, which commenced in the fourth quarter of 2006, can be ascribed to the strong demand for housing at the lower end of the market causing prices in this segment to increase at a brisk pace.

Middle-segment housing

Nominal house prices in the middle-market segment (houses of 80m-400m and priced at up to R2,7 million) increased by an average of 15,5% y/y to about R892 500 in the first quarter of 2007. In real terms, house price growth in this category came to 9,3% y/y in the first quarter. In both nominal and real terms, the year-on-year growth in house prices in the first quarter was up on that of the fourth quarter of 2006, when it was a nominal 14,8% and a real 8,8%. This development came on the back of strong growth in transaction volumes in the first three months of the year after interest rates were left unchanged during this period.

In the three middle-segment categories, house price growth was as follows in the first quarter of 2007:

• Small houses (80m-140m): a nominal 12,6% and a real 6,6% higher.
• Medium houses (141m-220m): a nominal 18,4% and a real 12,1% higher.
• Large houses (221m-400m): a nominal 16,1% and a real 9,8% higher.

Luxury housing

Nominal house prices in this segment (houses valued at between R2,7 million and R9,9 million) increased by an average of 7,6% y/y to around R3,9 million in the first quarter of 2007 (9,6% y/y in the final quarter of 2006). In real terms, house prices in the luxury category increased by 1,8% y/y in the first quarter (3,9% y/y in the fourth quarter of last year).

The low growth in house prices at the upper end of the market is related to a strong supply of properties in this market segment during recent years, whereas demand started to taper off in late 2004 because of the high prices caused by strong price growth in 2003 and 2004.

Regional house prices

On a provincial basis, nominal year-on-year growth in house prices in the middle segment of the housing market varied from as low as 5,2% in KwaZulu-Natal to as high as 28,2% in the Northern Cape in the first quarter of 2007.

In the countrys major metropolitan areas, nominal house price growth in the first quarter of the year varied from 9,0% y/y in the Durban/Pinetown area to 26,1% y/y in the central and southern parts of Johannesburg.

Building costs and new and existing house price trends

The cost of building a new house increased by a nominal 10,6% y/y in the first quarter of 2007, compared with a growth rate of 11,1% y/y in the preceding quarter. Building costs continued to increase at rates well above inflation, driven by factors such as the strong demand for building materials and skilled labour caused by high levels of activity in the building and construction sector.

The average price of a new house increased by a nominal 16,0% y/y to about R910 300 in the first quarter of 2007, which implied an increase of 9,5% y/y in real terms. The average price of an existing house increased by a nominal 15,3% y/y to about R888 500 in the first quarter, which brought the real price increase to 8,9% y/y.

The nominal price difference between new and existing houses was 2,3%, or about R21 800, during the first quarter of 2007. The price difference between new and existing houses levelled out during the past twelve months after a sharply declining trend since mid-2003. In that year, it reached an all-time high of R175 100, or 31,4%.

Land prices

In the first quarter of 2007, nominal land prices increased by 22,7% y/y to about R328 300 on average, compared with growth of 22,1% y/y in the fourth quarter of last year. Real growth of 16,1% y/y was recorded in the first quarter, compared with growth of 15,7% y/y in the preceding quarter.

The scarcity of suitable and properly serviced land for residential development has assumed importance, especially in the rapidly growing metropolitan areas of the country. This situation is not expected to improve materially and will increasingly be reflected in vacant land prices in years to come. Along the coast, the value of residential land with good views has also increased significantly over the past few years. As the supply of and demand for vacant land are, to a large extent, moving in opposite directions in the coastal and major metropolitan regions, residential land prices are expected to escalate further in future.

Mortgage finance

Commercial banks variable mortgage interest rates were stable at 12,5% in the first few months of 2007 after lending rates had been hiked by a total of 200 basis points between June and December last year.

Based on an average house price of R892 492 in the middle segment of the market in the first quarter of 2007, the monthly repayment on a new mortgage (100% over a 20-year repayment period at a variable mortgage rate averaging 12,5%) amounted to R10 140. In the same quarter of 2006, the comparable repayment was R7 714, calculated at an average house price of R772 614 and a mortgage rate of 10,5% at the time. The difference of R2 426 between these monthly repayments can be ascribed to house prices being 15,5% higher in the past quarter than they were a year ago, whereas the mortgage rate was 200 basis points higher than in the first quarter of 2006.

Affordability of housing

In view of the abovementioned house price and interest rate developments, the gross monthly household income required to qualify for a 100% mortgage on a R892 492 house for which the monthly repayment does not exceed 30% of income was R33 800 in the first quarter of 2007. This was 31,5% higher than a year ago, when a monthly household income of R25 712 was required to qualify for a 100% mortgage on a R772 614 house.

House price growth has been on a declining trend over the past twelve months. The steady increase in interest rates since mid-2006 has been a major contributor to the increasein the year-on-year growth in the required income from 12,7% in the first quarter of last year to 31,5% in the first quarter of this year.

The house price-to-remuneration ratio tapered off somewhat in the third quarter of last year (most recent remuneration data available), mainly as a result of strong nominal growth of 8,1% y/y in the remuneration per worker in the non-agricultural sectors of the economy, with year-on- year house price growth declining further at the time.

The ratio of mortgage repayments to remuneration increased further in the third quarter of last year to its highest level since the first quarter of 1992. The higher interest rates since June last year largely contributed to this development.

An increase in the abovementioned two affordability ratios implies that house prices and mortgage repayments are rising at a faster rate than remuneration, which means that housing is, in effect, becoming less affordable.

Outlook

Inflation is currently under upward pressure on the back of volatility in international oil prices and the rand exchange rate, which caused domestic fuel prices to increase sharply in recent months. The drought conditions and devastating fires which recently occurred in some agricultural regionsaround the country are expected to push food price inflation to higher levels in the near future. These trends do not bode well for overall inflationary pressures over the short term, especially taking into account that food has a weighting of as high as 25,7% in the overall CPIX index.

In view of inflation expected to rise further in coming months, together with factors such as the continued strong growth in domestic credit extension; increasing household debt levels and debt servicing costs; and a substantial current account deficit, the risk for interest rates over the short term is on the upside.

Against this background, nominal house price growth is forecast to average 13,1% (7,2% in real terms) in 2007, compared with a growth rate of 15,3% (10,2% in real terms) recorded in 2006.

In 2007, the housing market will to a large extent be driven by the combined effect of a wide range of factors, such as the availability and cost of serviced land for residential development; building cost increases and inflation trends; interest rate movements; the overall performance of the economy; growth in the real disposable income of households; trends in household debt levels (which will, together with interest rate developments, influence the cost of debt servicing); and the affordability of housing.

Courtesy Jacques du Toit Senior Economist ABSA Bank