| 06 Mar 2007 |
Article by John Loos |
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John Loos suggests that building costs could be the key to a residential
market recovery.
Some people may say that, after a boom of such extreme magnitudes as the one
of 1999 to around 2005, and very respectable house price inflation rates albeit
slowing in 2005 and 2006, I must be absolutely crazy to suggest that there could
be a house price inflation recovery as soon as 2008.
What keeps me bullish regarding the rest of the decade's housing market
performance then? One simple word - SCARCITY.
Whereas new house price inflation was predominantly "demand-pull" inflation
during the main boom years, it would appear to be starting to revert to
"cost-push" inflation, and that "cost-push" is becoming very strong.
This is apparent in Industryinsight's Residential Building Cost Index, which
measures residential building contractor pricing. The most recent inflation rate
was 23.3% year-on-year in October 2006. This is a major increase from 0.8% as at
December 2005. The meteoric rise goes hand-in-hand with a sharp rise in building
material inflation from 4.6% as at January 2006 to 14.7% as at November 2006,
while skills and some related services are also reported to be in short supply.
The sharp rise in building cost inflation, ironically, comes at a time when
residential building activity growth is subsiding steadily. Year-on-year growth
in residential buildings completed (number of units) was negative to the tune of
- 6.5% year-on-year for the 3 month period to November 2006.
Normally, one would expect that in times of weak demand for residential units,
and thus slowing supply of new stock, building cost inflation would be on the
low side.
The lesson we are beginning to learn is that you analyse residential property in
isolation from commercial property and infrastructure development at you peril.
They all hang together in these times of higher economic growth because they are
all competing to a greater or lesser extent for increasingly scarce skills and
materials.
This is reflected by overall real construction sector value added growth of
14.3% at a quarter-on-quarter annualised rate in Q3 2006, and similar growth in
prior quarters. This growth is the combination of still significant residential
building activity, increasing commercial property building activity,
proliferating government infrastructure projects, and perhaps the early stages
of some 2010 preparations.
With commercial property vacancies having declined over a few years, and with
industrial space especially tough to acquire in most of the major centres, a
frantic pace of development of new space will be required to match demand.
Rental inflation in both office and industrial space has been accelerating, and
high double digit inflation rates are becoming the order of the day in many
areas.
With commercial property returns impressive (30.1% in 2005 according to IPD and
possibly equally impressive or better in 2006), the residential property sector
will have its work cut out in competing for many of the scarce resources needed
for new development, and this could play a key role in limiting the supply of
new residential stock.
But a sharp rise in building cost inflation over the next few years is only one
(albeit important) piece of the jigsaw puzzle. The other factor is the economy.
Real economic growth appears to have shifted up a gear in recent years, into the
4-5% range.
Solid economic growth by SA's historic standards implies more rapid growth of
overall household disposable income, a more rapid growth rate in middle class
numbers, and all this leads to more rapid growth in housing demand. More rapid
economic growth also places huge demands on infrastructure, which is the reason
why the construction sector is booming the way it is.
Over the rest of the decade, it is this combination of more rapid housing demand
growth coupled with sharply rising building cost inflation and limits on growth
in new housing stock that is key to a relatively bullish picture on the housing
market.
It will be a different kind of growth to the boom years that have passed and a
little less extreme. Whereas the main boom years were driven by extreme demand
growth as a result of interest rates dropping from a peak of 25.5% prime late in
1998 to 10.5% by 2005, the expected strengthening from 2008 will be driven more
by the combination of solid economic growth and growing constraints in housing
supply, with interest rate reductions being very small in magnitude and thus
playing a small role.
The 2010 World Cup will indeed play a role, but this role must not be
exaggerated. It is unlikely that masses of individuals will drive up residential
property prices by purchasing houses with the sole aim of making money from
football supporter tenants over the one month world cup period.
Rather, the impact of the World Cup will be experienced via the further pressure
that it exerts on the construction sector. A good number of billion rands' worth
of stadiums and related infrastructure need to be built over the next few years.
Furthermore, certain government-led infrastructure projects that would have
taken place regardless of 2010 will be fast tracked for completion for 2010,
either because they are required for the event of because of the positive impact
they may have on SA's image, creating a further construction industry "crunch".
2010 will also impact positively on the economy. Apart from a short spike in
economic growth caused by a massive influx of spectators and officials for the
World Cup, the event will greatly boost SA's image as a place with good
infrastructure, good organisational skills, and a great functions and events
destination. We have already some time been on a path of building such an image
with the hosting of other sporting world cups, African Nations Cup soccer, and
major global conferences (e.g. earth summit) at very fine convention centres
that have sprung up. But the world cup is another step up for the "events
industry" and is arguably second only to the Olympics, with billions of people
watching on TV.
So, while the direct net benefits of a world cup are always debatable, I believe
that SA will gain hugely in terms of its image, which has often been held back
purely by the fact that the country is on the African continent.
Such image benefits can translate into better economic growth in the ensuing
years than would otherwise have been the case, but that is a period post-2010
rather than prior.
For now, therefore, the benefits of the World Cup in terms of house price are
expected to come predominantly from the added constraints that it will place on
the construction sector.
The final source of price pressure will come from increasing land scarcity
around major metros especially. Not only are metros beginning to place limits on
unbridled urban sprawl, but the authorities are also unintentionally restricting
urban sprawl by being unable to keep up with the demand for new infrastructure,
the most important arguably being transport infrastructure. Increasing traffic
congestion accompanied by limited new road development makes it tough to just
develop new residential property further and further away from business nodes.
Watch housing prices around Sandton, for example, soar in years to come as
traffic congestion gets worse and many high income people try to live closer and
closer to work. Watch top quality schools becoming key drivers of house price
inflation in their vicinity, as many choose to live closer so as to avoid a
1-hour commute in each direction merely to drop their children off. Then there
will be another group "fleeing" the chaos of the cities to smaller towns not too
far away from the city, where infrastructure is less under pressure.
Acknowledged, residential property price inflation remains on a declining path
for the time being. But looking at the longer term, and given the combination of
mounting land and construction supply constraints, caused by more impressive
economic growth than we've had in decades and exacerbated by 2010, the longer
term performance looks to be bright, perhaps not for those trying to acquire
property, but from a point of view of those that will own it.
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