Real house prices continue the gradual correction

by John Loos

In October 2017, the FNB House Price Index showed a further mild acceleration in year on year growth compared with revised September growth. However, at 4.3% the rate remains noticeably lower than both consumer price and rental inflation, implying that FNB’s two measures of “real” house prices –  the price-rent ratio index and the real (CPI-adjusted) FNB house price index continue their downward corrections.

According to StatsSA CPI figures, residential rental inflation has been outstripping average house price inflation of late. This has been instrumental in another aspect of the housing market’s slow correction, lowering the average house price-rent ratio.

The price-rent ratio is one important ratio in determining how costly the home buying option is relative to a key competing option, rental. It is merely another form of real house price calculation, comparing house prices against the competing rental option in much the same way as we compare house prices to competing consumer goods and services price levels when compiling what we usually call real house prices.

Analysts often become concerned when the price-rent ratio is very high, as it can begin to make the rental option relatively more appealing, contributing at some stage to a drop in home buying and a fall in house prices. House price booms, or strong market periods at least, typically take this ratio higher.

To this effect, we use the FNB House Price Index and the CPI for actual rentals to monitor this ratio. We show it in index form (because the CPI is an index), with January 2008=100.

In recent months, the FNB house price-rent ratio index has resumed its broad gradual declining trend that started early in 2016.

From a nine-year high of 88.13 reached in November 2015, the house price-rent index has declined by -4.6% cumulatively to reach an 84.08 level in September 2017.

This decline is the combination of average rental inflation, according to CPI rental statistics, accelerating to 5.68% year on year in the September CPI numbers, whereas average house price inflation for September was a slower 4.2% year on year.

This brings the cumulative longer term decline in the price-rent ratio index to -15.92% since January 2008, a time when the pre-2008 house price boom had left the price-rent ratio at extreme highs by historic standards.

While 84.08 represents a noticeable correction in the price-rent ratio index since the 100 level of January 2008, it is still believed to be a high number.

However, the other important ratio, the Instalment on a 100% bond on the average-priced house/rent ratio index, remains somewhat lower at 71.6 (with January 2008 = 100 for this index too). It has been kept well below January 2008 levels by relatively low interest rates which, even despite a rise of 200 basis points since early 2014, remain significantly below mid-2008 peak levels. This index is a very significant -28.4% below January 2008 level, and in part explains why a still-high price-rent ratio has not led to a very strong surge in demand for the rental option in recent years.

Examining the real house price trends (house prices adjusted for overall CPI inflation), we see that the level in September 2017 had lost-4.9% since a near nine-year high reached in December 2015.

Looking a bit further back to the all-time real house price peak at the end of 2007 (at the end of the pre-2008 housing boom period), on a cumulative basis real house prices were -19.6% down on that high as at September 2017.

However, looking back even further, despite a mediocre performance in recent years, the average real house price currently remains a massive 63.9% above the end-2000 level, almost 17 years ago, and a time just before boom-time price inflation started to accelerate rapidly.

In short, we believe both of our versions of real house prices – the FNB House Price-Rent Ratio Index (Average house price-CPI-Rentals Ratio) and the FNB Real House Price Index (Average House Price-Overall CPI Ratio) – to still be at relatively high levels, but in both indices the downward corrections continued in September 2017, and the cumulative corrections in both since end-2007,beginning-2008 have been significant at between -15% and -20%.

Looking at the FNB House Price Index for October 2017, we saw growth of 4.3% year on year. This is a mild acceleration from the revised 4.2% for September, but still likely to be significantly below CPI and CPI-rental inflation rates, both most recently above 5%.

In real terms, when adjusting for CPI inflation, this translated into a decline of -0.9% year on year in September (October CPI data not yet available). This is a noticeably diminished real house price deflation rate from a low of -5% reached in December 2016.

The -0.9% real price decline in September was due to a CPI inflation rate of 5.1% in that month, remaining +0.9 of a percentage point above the 4,2% year on year house price inflation rate of the same month.

While the year on year house price growth rate has still recently shown mild acceleration, a better way to be up to date on most recent house price growth momentum is to view it on a month on month seasonally-adjusted basis. And a steadily slowing month on month growth rate suggests that year on year house price growth should also start to slow soon, likely sustaining the recent period of real house price decline.

Calculating house price growth on a month on-month basis we have seen a slowing price growth trend, which started in April 2017.

The month on month house price growth rate was a lowly 0.06% for October, down from the prior month’s 0.12% and now well-down on the 2017 high of 0.83% reached in March.

Annualising the most recent month on month price growth rate of 0.06%, we see that, were that month on month growth to continue over the next year at the same lowly rate, the FNB House Price Index would achieve a mere 0.7% year on year growth 12 months from now. It is thus likely that year on year house price growth will remain below the CPI inflation rate, and thus negative in real terms, in the near term.

This most recent month on month slowing house price growth trend once again has broadly coincided with a marked dip in the Absa manufacturing sector purchasing managers index (PMI), suggesting that it is reflective of a renewed economic “dip” after a brief economic growth improvement in the second quarter of 2017 which ended the prior two quarter recession.

Not only does the recent slowing month on month house price growth rate point to possible renewed weakening in the economy, but also to the likelihood that year on year house price growth may soon begin to slow once more. This would likely keep house price growth below rental and overall CPI inflation, sustaining the gradual real house price and price-rent ratio corrections in the near term.

As a matter of interest, in the FNB Estate Agent Survey, among the sample of agents surveyed quarterly we see that these agents appear to anticipate recent low single-digit house price growth rates to continue over the next 12 months.

In the third quarter 2017 survey, on average they expected house price growth over the next 12 months to amount to 4.2%. This is mildly less optimistic than the previous quarter’s 4.5%, and now noticeably lower than the multi-year high expectation of 5.9% reached in the second quarter 2015 survey.

In recent times, agents surveyed have reported heightened levels of economic stress/general pessimism in the markets in which they operate, while a diminished number report positive consumer sentiment.

John Loos is the household and property sector strategist at FNB Home Loans.