The affordability challenge

by John Loos

The release of StatsSA building statistics for June completed the second quarter picture for the residential building sector, and a sharply weakening near term picture has become increasingly likely.

For some time, the FNB-BER Building Confidence Survey has been telling us not only of weakness at the front of the new development pipeline, but also of survey respondents pointing to deteriorating profitability in the residential building sector for some time.

And indeed, a look at the residential building stats of StatsSA points to a development sector having battled to bring competitively priced new housing stock to a market where the existing home market is well-supplied and real home values have been in decline for quite some time.

The StatsSA Residential Building Statistics show that building completions growth have arguably been surprisingly strong at a time when the country is well into its longest business cycle downward phase in the post-World War 2 period, and the existing residential market is well supplied and showing real price declines.

In the second quarter of 2019, year on year growth in residential units completed was a strong 47.9%, only marginally slower than the first quarter’s 48.3%. These two quarterly growth rates in the first half of 2019 were the highest growth rates since mid-2004.

And reaching 12 661 in the second quarter of 2019, the quarter’s number of residential units completed was the highest in almost a decade too, since the 14 618 units completed in the final quarter of 2019 in the aftermath of the pre-2008 housing bubble.

However, these levels by no means represent boom times, remaining fairly modest compared to the 20 284 units completed in the second quarter of 2007, at the peak of last decade’s building boom.

It has, however, been an interesting “mini-surge” in completions levels over the past year or so, coming at a time when both the economic and property market cycles have been in a downward phase. One factor perhaps having been mildly in the residential building sector’s favour, though, has been the residential mortgage lending sector’s attempts to grow their lending where there is little natural market growth, through increasing lending appetite and approval rates, as well as squeezing home loan pricing to become more competitive.

But lending appetite aside, this surge just appears to be a natural lag of the property and economic cycle due to the long time lag from when planning of projects starts until completion.

If we now turn to a more forward looking indicator – the number of units’ plans passed – a leading indicator of the direction of building completions to come in future, then we see what appears to be a response emerging to the weaker economic and market conditions, that is, a sharp decline in plans passed.

The number of units’ plans passed declined year on year by -24.8%, after a first quarter decline of -13.7% and the third consecutive quarter of year on year decline.

These quarterly declines should begin to feed through into weaker completions growth in the very near term

The year on year inflation rate in the value per square metre of plans passed and plans completed have both broadly slowed, as the slower existing home market, with real average price deflation, has made it increasingly tough for the new development sector to compete with existing prices.

However, at just over 6% year on year inflation per quarter for the first two quarters of 2019, average value per square metre of new completions still inflates at above the FNB House Price Index for existing houses, whose rate is  around 3.5% year on year through this period.

And over the past decade or more, the inflation rate in value per square metre of plans passed has far out-paced existing house price inflation.

We compile two indices with base year 2007 = 100, using the FNB Existing House Price Index and the average value per square metre of residential building plans passed. We take 2007 because this was the tail end of last decade’s residential building boom. From 2007 onward, the index for average value of plans passed per square metre out-inflated the FNB Existing House Price Index to the extent that it was 51% higher than the latter index by the second quarter of 2019.

This gives an idea to what extent new building values have become less competitive since 2007, and largely explains why, even despite a little surge in completions of late, building completions remain well below the levels of 2007 and prior years.

Examining affordability on completed units relative to average employee remuneration, we have also seen a noticeable deterioration since around 2013.

We compile two affordability indices for new residential units completed. The first one is the average value of units completed/average employee remuneration index (in index form because the employee remuneration time series is in index form). This index was 42.6% higher – affordability had deteriorated – by the end of 2018 compared to its mid-2012 level.

We then compile a second index which relates more to credit-dependent purchases and the cost of credit, that is the instalment repayment value on a 100% bond on the average unit competed value/average employee remuneration index.

This index is thus not only influenced by average value of units completed and employee remuneration trends, but also by interest rate changes and levels.

Given that interest rates today – despite a recent small reduction – are mildly higher than back in 2012, this index has risen by slightly more than the first affordability index, and by the end of 2018 was 59.3% above an early-2013 multi-year low.

So building cost inflation relative to household incomes and existing house price growth appear to have made it tougher for the new development sector to bring competitively priced stock to the market.

One would expect to see a response to the affordability challenge, which would either include more economical land use (densification) or building of smaller units or units with fewer “frills”.

It would appear that an intensified drive to use land more efficiently has been the order of the day in recent years, as opposed to building smaller average-sized units. The average size of units built has come down over the long term since the 1970s, but over the past seven years it has actually increased, perhaps surprisingly.

From a decade low of 107.4 m2 early in 2013, the average size of units completed had risen to 159.1 m2 by the second quarter of 2019.

This would perhaps appear a little out of place in the recent period of economic stagnation and toughening financial conditions for households.

However, there can be two reasons for this. It is possible that a lower portion of the overall building activity is taking place of late in the affordable housing market, but that is tough to ascertain. But secondly, a more detailed look at the data shows a big drive to build far more flats and townhouses as a share of the total market in recent years.

We have seen the flats and townhouses category of units completed increasing its share of total completions sharply, from 23.56% back in 2011 to a dominant 60.6% by 2019 to date. This is likely densification, much of this segment likely even being multi-storey.

Losing share the most significantly is the free standing homes (dwelling houses) smaller than 80 m2 in size, from 48.15% of total completions back in 2011 to 19.08% as at 2019 to date.

Losing share too, albeit more moderately, was the dwelling houses larger than 80 m2 category, the larger free-standing home category. Its share shrank from 28.3% in 2011 to 20.3% by 2019 to date.

Therefore, the response from the development sector to affordability challenges appears to have been more in the form of more economic land use and densification in terms of land and less in terms of average unit size.

The trend looks set to continue if one looks and the rising share of flats ad townhouses plans passed too. In 2019 to date, 54.5% of plans passed were flats and townhouses, up from 27.9% in 2011.

In Conclusion, StatsSA building statistics point to relatively solid growth in residential building completions, and suggest that the level of completions is at its highest in almost a decade.

However, South Africa is into the longest business cycle downturn in the post-World War 2 era, the existing home market is well-supplied and price-competitive, and new residential building affordability has deteriorated according to our affordability indices.

Therefore, a slowdown in the level of residential completions in the near term should be expected given the current environment. And indeed, a further sharp year on year decline in the number of residential units’ plans passed, a useful leading indicator for building activity trends, suggests that such a near term slowing is likely.

As the development sector attempts to address the heightened affordability challenge in a tough economic environment, the emphasis has been increasingly on flats and townhouses as opposed to free standing homes, the data would suggest. We would also expect to see the average size of units passed and planned start to decline, something which hasn’t happened in recent years according to this data.

John Loos is the property sector strategist at FNB Commercial Property Finance.