Property Market

Private Property South Africa
John Loos

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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