Although nominal South African house prices have more than doubled since the beginning of 1999, this does not mean that South Africa is currently experiencing a house price bubble as the real price of houses is still 20% below the 1983 peak, South African commercial bank Absa said on Tuesday.
The average South African house price has risen to R452 000 in October 2003 from R225 000 almost five years ago. This is still well below Australian and British average house prices of A$368 800 (R1,83-million) and GBP161 665 ($1,87-million)
Last week both the Reserve Bank of Australia and the Bank of England raised interest rates, in part due to the need to cool down an overheated property market.
The International Monetary Fund (IMF) in its April 2003 World Economic Outlook warned that several countries such as Australia, the UK and the US were experiencing house price bubbles, which could have severe repercussions in the future.
The IMF said an important theme running through an analysis of asset price busts and their impact on output was that that housing price busts have been associated with more severe macroeconomic and financial developments than equity price busts.
This reflected several factors, including larger wealth effects on consumption, deeper effects on the banking system, the need to unwind greater imbalances, and the higher degree of contagion across asset classes.
Concerns about South Africa’s recent doubling in house prices were also expressed at last week’s Monetary Policy Forum, but South African Reserve Bank officials said house prices were playing catch up to other asset classes and on a relative price basis were not over-priced.
Jacques du Toit, the Absa senior economist who addressed this issue in a paper released on Tuesday, agreed with that assessment. According to Du Toit, a generally accepted method of determining the
affordability of housing, as well as whether or not the residential property market is in a bubble, is to calculate the ratio between house prices and the level of remuneration.
In 2002, in countries such as the US, Australia, Spain, the Netherlands and Ireland, this ratio reached its highest level since the late-1970s. In Britain, it was at a record level since the late-1980s.
Although the South African ratio is currently at its highest level since early 1992, it remains nowhere near the record high reached in the early- to mid-1980s, when house prices increased by as much as 30% y/y, Du Toit states.
Another method to determine whether the residential property market is in a bubble is to calculate the level of house prices in real terms (that is, excluding inflation).
According to this calculation, house prices have increased significantly in real terms over the past three years, but last year were still 30% below the historical high reached in 1983 on average. In the first three quarters of 2003 real house prices were 20% below the 1983 record high on average.
A further indication of the existence of a bubble in the residential property market is the comparison of the average price of new and existing houses in order to determine whether existing houses are overvalued in relation to new houses.
This analysis indicates that, with the residential property market at its peak back in 1983, the price difference between new and existing houses had declined to almost zero at the time, after which the price difference turned negative, that is, new houses became cheaper on average than existing houses.
From 1990 up to 2003, new houses were on average 25% more expensive than existing houses. This implies that existing houses have generally been below their replacement value over the past thirteen years. During the nine months up to September 2003 the price difference between new and existing came to 30.8% on
average.
Du Toit says that a very important factor currently present in the domestic residential property market is the declining trend in interest rates since June this year. A decline in interest rates supports the housing market by lowering mortgage instalments and therefore increasing the demand for housing.
Alternatively, lower interest rates imply an increase in the amount of the mortgage that can be raised, keeping the term of the loan and the mortgage instalment constant.
“There would not yet seem to be a bubble in the South African residential property market, although such a situation could have arisen in certain areas for specific types of housing,” Du Toit concluded. – I-Net Bridge