Drivers of house prices revisited
The normal short-term factors that drive house-price inflation are economic growth (real growth in disposable household income) and interest rates, as both affect affordability.
According to a report by Rode and Associates economic growth also tends to create new jobs, which boosts the demand for housing, and if the supply side (new developments) cannot keep up, prices accelerate. In a booming economy, this lag time is a real problem as the gestation period of new residential estates is about four years.
The report states that a long-term driver is construction costs. The reason for this is the substitution principle. If the prices of existing houses rise to levels where it is cheaper to build new, the potential buyer might choose the new build. Thus, the cost to build new keeps the prices of existing stock in check.
Exceptional factors that could affect house prices are migration and the insistence by some municipalities on inclusionary (low-cost) housing in higher-priced developments. These factors are wildcards and are not contained in forecasting models:
- Migration of well-qualified people to a country or a city when the supply of new houses cannot keep up with the influx. Cape Town experienced this phenomenon towards the end of the Zuma era as a result of ‘semi-migration’ from the rest of the country. On the western seaboard of North America and in some Australian cities (to mention a few successful conurbations), Chinese buying properties have had a similar effect.
- The City of Johannesburg has already, and the other major cities are planning to implement policies that would force developers to include low-cost housing in their middle-class developments. As always, the devil is in the detail, and unless such policies are carefully crafted, it has the potential to disrupt the supply of new houses, which would eventually create a scarcity of middle-class housing.
Interest rates is a ‘normal’ driver of prices. They can be modelled and can impact house inflation in two ways:
- When interest rates are ultralow in absolute terms through financial engineering – as many countries have had since the Great Crash in 2008 – affordability is greatly boosted, resulting in an artificial boom in prices, even though the economy might be showing pedestrian growth. Should interest rates be normalised to more sustainable levels one day, imagine what that would do to house prices and other assets in those countries that now have policies of near-zero interest rates.
- During periods of demand-pull inflation, as SA had during the second half of the 1970s and 1980s, interest rates are generally low relative to consumer and house-price inflation, which makes financial gearing very profitable. Thus, the home investor builds capital as the capital return, together with the income return, outpaces the interest cost of a mortgage. This causes a self-reinforcing buying frenzy.
The Rode report further states that the thing about an era of demand-pull inflation is that interest rates are at times positively correlated with house-price inflation. The explanation for this weird phenomenon is that the monetary authorities do raise interest rates to combat inflation, but not fast enough. Thus, financial gearing stays positive. This happened in South Africa when the Reserve Bank wasn’t independent from the government and the government, in the precarious political situation of the time, wasn’t prepared to face the political fallout of rising interest rates. This explains why the independence of the Reserve Bank was written into the Constitution.
Amid expectations that property would crash during the pandemic, South African house prices surprised by rising by 3.05% last year, according to the property and vehicle research group Lightstone. This was in line with inflation, and stronger than house-price growth of below 2% in 2019.
As the fallout from the pandemic and lockdown continues to hurt the local economy, a similar impact was expected on the residential property market, with experts predicting that house prices could fall by between 5% and almost 15% this year.
Lightstone reported that the mid-value segment (properties priced at R250,000 to R700,000) fared best, gaining 4.9% in 2020. In 2019, these property prices only grew by 3.6%.
The low-priced category (below R250,000), high (R700,000 to R1.5 million) and luxury (above R1.5 million) properties grew 2.5% last year. By comparison, the luxury segment that has been trending closer to -0.5% at the end of 2019. But low value houses have seen their price growth fall from 10.2% in 2019 to 2.5%.
Demand-pull inflation can be described as too much money chasing too few goods in a fast-growing economy. This allows retailers and other role players in the economy to get away with price increases that would otherwise not be feasible.
In contrast, cost-push inflation is caused by increased costs of production (increased labour costs, increased costs of raw materials). Furthermore, a weakening rand hikes the prices of not only imported goods but also the prices of locally manufactured goods via import-parity.
Location plays a role in the value of a property. A brick put down in an upmarket suburb adds more value than the same brick put down in a down market area. Similarly, being close to an informal settlement is not value-enhancing. However, when buying an existing home, this negative should be priced in already. The same applies to a house next to a busy street or in a crime-ridden area.
About ageing and changing tastes
Fashions come and go, and this also apply to the layout, building materials and finishes of a property. Houses age like everything in the universe. For this reason, a valuer cannot compare the price achieved by a 30-year old house with a 1-year old home without making an adjustment for ageing.
As a matter of interest, architectural style does not add or subtract from value. The explanation is that what is horrid to one potential buyer is acceptable or even pleasing to another.
When contemplating adding to your existing house, the first rule is to be compliant with the municipality’s bylaws. Submit plans and don’t take shortcuts. But beware of overcapitalizing.
Adding a granny flat to a house on a large stand could be profitable as the stand is free and the renting of granny flats is growing in popularity. In addition, municipalities like them because they densify the urban space.