SA Property Barometer - Residential Market Stability Risk Review
Residential Market stability risk continued its recent decline (improvement), mostly due to positive Household Sector and Housing Market-specific factors but with little help from the broader economy
Residential Market risk continued to decline (improve) in the 3rd quarter of 2016. This is mostly due to improvement in certain key household and residential-specific factors, such as the declining trend in the Household Debt-to-Disposable Income Ratio and low levels of risk of speculative activity and over-exuberant home buying.
However, high risks to the broader macro-economy continue to work in part against these positive developments.
The risks to the future stability of the housing market continued to decline (improve) during the 3rd quarter of 2016.
- On the Household Sector side, the ongoing decline in the Household Sector Debt-to-Disposable Income Ratio remains a key positive, lowering the important Household Debt-Service Risk Index.
- A dismal rate of Household Savings remains a long term negative contributor to Housing Market Risk, however.
- The start of a slight improvement in Housing Affordability in a slowing property market has also just started to become a contributor to declining risk.
- A further key positive is that there exists a low risk of speculation and “over-exuberance” in the market, due to interest rates that are higher than the relatively benign house price inflation rates.
- Therefore, behavior in the Housing Market itself does not promote a “High Risk” situation, and the Composite Housing Market Risk Index, which excludes broader Macroeconomic Risks emanating from outside of the Residential Market, remains firmly in “Medium Risk” territory at 29.36 (scale of 0 to 60) and steadily declining (improving).
- The state of the country’s broader economy is what poses more significant risks to the Housing Market, however, with big Macroeconomic imbalances having built up. These include a wide Current Account Deficit, a steadily rising Government Debt burden, and already-low real interest rate levels at a time when the economy hardly grows.
- Our Composite Household Sector, Residential Market and Economic Risk rating, the over-riding risk index which incorporates Household Sector, Housing Market and Macroeconomic Risk Indicators, finally breached the “High Risk” lower boundary in the 3rd quarter of 2016, to move into the “Medium Risk” zone. From the previous quarter’s 17.29 (on a scale of 0 to 30), this index declined further to 16.98, the 3rd successive quarter of decline (improvement).
OVERVIEW: RESIDENTIAL MARKET RISK DECLINES (IMPROVES) IN RECENT QUARTERS
The risks to the future stability of the housing market continued the improving trend during the 3rd quarter of 2016. This is the continuation of a decline in risk levels since late in 2015. The risk improvement has been driven by a combination of Household Sector- and Housing Market-specific factors, which offset weak Macroeconomic factors.
On the Household Sector side, the ongoing decline in the Household Sector Debt-to-Disposable Income Ratio, all the way from 87.8% as at the 1st quarter of 2008 to 74% by the 3rd quarter of 2016, has lowered the vulnerability of the Household Sector significantly through lowering its sensitivity especially to interest rate hiking. Given that much of this indebtedness decline is due to a decline in the Household Mortgage Debt-to-Disposable Income Ratio too, this contributes significantly to lower residential market vulnerability to economic and interest rate “shocks”.
In addition, there exists a low and diminishing risk of speculation and “over-exuberance” in the market, due to interest rates that have risen gradually since 2014 to a percentage significantly above now-lowly house price growth. Slow Household Disposable Income growth is also a positive in the sense that it contains consumer confidence and promotes conservative household spending. These factors are not good news from a market strength point of view, but are positives in terms of limiting any risk build up in the market that can come from “over-exuberant” property buying and the financial over-commitment that this can bring.
In addition, a significant and widening cost gap between the more expensive new home building and existing home buying greatly curtails any possibility of “over-building” and thus oversupply.
There are 2 factors within the Household Sector and Housing Market which still contribute negatively to Household Sector and Housing Market vulnerability. Firstly there is the matter of a dismally low Household Sector Savings Rate. And secondly is the issue of still relatively poor levels of home affordability, with real home values, the house price- to-rent ratio, and the house price-to-per capita income ratio all at what are high levels by long run historic averages.
Overall, though, behavior in the Household Sector and Housing Market itself has in recent times promoted a “Medium Risk” situation, and indeed a declining risk situation, all in all a very positive development from a Financial Sector stability point of view.
This is a dramatically improved situation to the extremely high risk situation created by the housing bubble back around 2007/2008. The Composite Household Sector and Housing Market Risk Index, which excludes broader Macroeconomic Risks emanating from outside of the Residential Market, remains very much in “Medium Risk” territory and declining steadily. At a level of 29.36 (scale of 0 to 60), this index has declined for 4 consecutive quarters from 33.45 in the 3rd quarter of 2015.
However, the state of the country’s broader economy is where the very significant risks to the Housing Market still linger, it would appear, with large Macroeconomic imbalances having built up.
Economic growth has been stagnating for some years, and as this happens, the social tensions mount, raising the risk of greater instability and economic disruption. Steadily rising Government indebtedness, with a 50.9% Government debt-to-GDP Ratio reaching its highest level in the 3-and-a-half decades over which the risk indices are compiled, along with relatively low real interest rates, point to limited fiscal and monetary stimulus possibilities for the economy at present. In addition, the country as a whole already lives well beyond its means, as reflected in a wide Current Account Deficit of -4.1% of GDP.
So the near zero-growth economy, which is major imbalances, is in a corner, and this poses very significant risk to the level of future residential demand.
Right now, economic growth remains under pressure, although possibly looking to turn slightly stronger. The OECD Leading Indicator for South Africa remained in year-on-year decline in the 3rd quarter of 2016. This rate of decline had diminished slightly, however, and there have been some moderately encouraging signs for some improvement in economic growth in 2017, including moderately higher global commodity prices to support domestic exports, and domestic drought conditions which look like being alleviated. But little points to a strong recovery, and economic mediocrity has a potentially constraining impact on near term residential demand.
In short, declining (improving) Residential Market risk is mostly due to key positive developments in terms of reducing vulnerability in the Household Sector and Housing Market itself, whereas broader economy-wide factors remain the negative contributors.
The broader “Macroeconomic” factors suggest that, even if the residential market remains “well-behaved” in terms of a healthy lack of “irrational” and “over-exuberant” behavior, there can be no guarantees against South Africa’s ailing economy exerting significant pressure on it.
Nevertheless, the risk improvements made in the Household Sector and Housing Market are the dominant influence in the overall Composite Household Sector, Residential Market and Economic Risk rating, the over-riding risk index which incorporates Household Sector, Housing Market and Macroeconomic Risk Indicators.
Therefore, this overall index, too, has seen a decline (improvement) from a multi-year high of 17.89 in the final quarter of 2015 to 16.98 (Scale of 0 to 30) by the 3rd quarter of 2016.
This Composite Index, however, remains on the border of the “High Risk” zone, having moved to just inside the “Medium Risk” zone in the 3rd quarter of 2016, kept relatively high by the risks existent in the broader economy at present.
In short, so the overall Composite Household Sector, Housing Market and Economic Risk Index remains vastly improved since the all-time high (worst) of 20.25 reached at a stage of stage of 2006, due to major improvements within the Household Sector and Housing Market itself. But it still remains on the high side due to the high level of broader economy-wide risks that have built up in recent years.
1. HOUSEHOLD DEBT-SERVICE RISK – RATING: 5.00 - MEDIUM
The rationale: The Household Debt-Service Risk Index attempts to look at the vulnerability of the Household Sector in terms of its future potential ability to service its debt.
The compilation of the Index: The index is compiled from 3 variables, namely, the debt-to-disposable income ratio of the household sector, the trend in the debt-to-disposable income ratio, and the level of interest rates relative to long term average (5-year average) consumer price inflation.
The higher the debt-to-disposable income ratio, the more vulnerable the household sector becomes to unwanted “shocks” such as interest rate hikes or downward pressure on disposable income. An upward trend in the debt-to disposable income ratio contributes negatively to the overall risk index (i.e. exerts upward pressure on the index) and vice versa for a downward trend. Then, the nearer prime rate gets to the “structural” inflation rate (using a 5-year average consumer inflation rate as a proxy), i.e. the lower this estimate of real interest rates becomes, the more vulnerable the household sector becomes, the reasoning being that the nearer we may be getting to the bottom of the interest rate cycle and the end of rate cutting relief, the more the risk of the next rate move being upward becomes, or at least the less the chance becomes of further cuts. In addition, households tend to make poorer borrowing and financial decisions on average, while it is tougher for lenders to assess aspirant borrowers, when money is cheap, so better borrowing/lending decisions are arguably made when interest rates are relatively high. Therefore, we view low interest rate periods as ones where risk generally builds up, and vice versa for periods of relatively high interest rates.
The Index: The Household Debt-Service Risk Index continues its steady decline (improvement), taking it convincingly away from the “High Risk” Band and well-into the “Medium Risk” zone, thanks to further decline in the Household Debt-to-Disposable Income Ratio.
From a 3rd Quarter 2012 multi-year high index level of 6.51 (on a scale of 1 to 10), the decline has taken this index all the way to a level of 5.00 by the 3rd quarter of 2016. This represents a significant decline (improvement) in the Household Debt-Service Risk Index.
This index has now reached its best (lowest) level since the 3rd quarter of 2003, and is now firmly in the “Medium Risk” Zone, having languished in the “High Risk” Zone for much of the 2004 to 2015 period.
The Key Drivers of the Index’s Recent Movement:
Keeping the Debt-Service Risk Index on its declining path has been a steady decline in the Household Debt-to-Disposable Income Ratio, whose pace of decline has picked up speed in recent quarters.
Some rise in the real interest rate level in recent years has also served to lower this risk rating.
2. HOUSEHOLD SECTOR SAVINGS RISK– RATING: 9.37 - HIGH
The rationale: We view the level of Household Sector savings to be important in understanding housing market risk. The Household Sector adjusts its consumption and saving habits as economic times change. The lower the savings rate at the time of some significant economic shock, the higher the risk of a more significant increase in savings and reduction in spending by households. Households could raise savings due to perceived job insecurity, or to compensate for a slowing growth in Net Wealth due to slower asset price growth.
This can be negative for both economic growth and housing demand in the short run. On the other hand, a high rate of savings already in place at the time of an economic shock may lower the risk of a dramatic reduction in already-low household spend.
The compilation of the Index
The index is compiled from 1 variable only, namely the Household Sector Net Savings Rate expressed as a percentage of Household Sector Disposable Income. This net savings rate refers to the gross savings rate adjusted for depreciation in fixed assets owned by the Household Sector. The weaker the net savings rate, the higher the risk rating and vice versa, on a scale of 0 to 10.
The Index: Household Sector Savings Risk remains extremely high, with little sign of a meaningful improvement in the country’s dismal savings rate.
The Household Sector Savings Risk Index remains extremely high, with a rating of 9.37 in the 3rd quarter of 2016 (on a scale of 0 to 10). This is a little higher than the previous quarter’s level of 9.30.
The Key Drivers of the Savings Risk Index’s Recent Movement:
The Net Savings rate remains very weak, in negative territory, sustaining a very high Savings Risk. Given a relatively slow growth rate in the value of Net Wealth of Households in recent quarters, we would anticipate the start of an improving trend in the savings rate. However, this has yet to materialize, hampered by recent weak real disposable income growth.
3. DISPOSABLE INCOME WINDFALL RISK– RATING: 3.25 LOW
The rationale: Household spending and borrowing behavior can tend to become more aggressive, or even reckless and highly risky, in times of “economic windfalls”. When abnormally big new job offers, bonuses, salary increases and dividend payments are the order of the day, such as in economic boom times, the big risk is that households begin to assume that these windfalls will continue forever, set their spending and borrowing commitments accordingly, and end up over-committed or overindebted. Times of abnormally high disposable income growth thus pose a high “Disposable Income Windfall” Risk, which can lead to “over-investment” in, and ultimate de-stabilisation of, the residential market.
The compilation of the Index
The index is compiled using long term Real Household Disposable Income growth. We calculate the 4-quarter average year-on-year growth rate in Real Disposable Income (our feeling is that a “windfall needs to be sustained for a while before it leads to recklessness, hence the 4-quarter average), and then calculate the differential between it and the long term Real Disposable Income growth average since 1970. The higher the 4-quarter average growth rate is relative to the long term average, the higher the risk rating is, and vice versa.
The Index: The Disposable Income Windfall Risk remains relatively low, having recently crossed the boundary from “Medium Risk” to the “Low Risk” boundary and posing little threat in this weak economic environment.
The Household Disposable Income Windfall Risk Index hovers on the border of the “Medium Risk” and “Low Risk” zones, just inside the “Low Risk” zone at a 3rd quarter 2016 level of 3.25. This is mildly lower (better) than the 3.33 level for the previous quarter.
Key Drivers of recent movement in Disposable Income Windfall Risk
Real Household Disposable Income growth recorded 1.4% year-on-year growth in the 3rd quarter of 2016. This was slightly down on the prior quarter. This is far below the 5.9% post-recession peak in 2011. Since 2013, the 4-quarter moving average growth rate has been consistently below the long term average, implying little threat of “Windfall Madness” in the current environment of poor consumer confidence.
4. RESIDENTIAL PROPERTY SPECULATIVE, PANIC AND OVER-EXUBERANCE RISK – RATING: 3.69 - MEDIUM
The rationale: The combination of strong house price growth and cheap credit can drive buying frenzies on an extreme scale. This can lead to market “overshoots”, and financial overcommitmenton a large scale.
It makes sense to speculate in such an environment, borrowing cheap credit to make quick capital gains before selling the property for a handsome profit. In addition, less seasoned investors see times of strong capital growth as the time to invest, seeing recent price growth as a predictor of future growth, often ignoring the rental yield. Big buy-to-let investment sprees thus often take place in such an environment.
Then there is the issue of 1st time “buyer panic”, where aspirant 1st time buyers fear that if they don’t buy quickly they won’t ever be able to afford a home in future. This can also spark a stampede.
House price growth relative to the interest rate level is thus a crucial in determining the risk of such behaviour emerging.
The compilation of the Index
The index is compiled using the FNB Long Term House Price Index year-on-year inflation rate, for its long term history, and a SARB Prime Mortgage rate time series. We calculate the “Alternative Real Prime Rate” which is the difference between the Prime Mortgage Rate and House Price Inflation. When house price inflation far exceeds the Prime Rate percentage, an environment conducive to widespread speculation, overexuberance and buyer panic emerges. A lower risk situation prevails when the Alternative Real Prime Rate is positive.
The Index: Speculative, Over-Exuberance and Buyer Panic Risk remains at the low end of the Medium Risk Range.
The Speculative, Over-Exuberance, and Buyer Panic Risk Rating declined further in the 3rd quarter of 2016 to 3.69 (scale of 0 to 10), from a previous level of 3.76. This level is at the low end of the Medium Risk Range and nearing the boundary of the “Low Risk” zone as it continues to decline (improve). It is now wellbelow the multi-decade high point reached in late-2004.
Key Drivers of recent trends in Speculative, Over-Exuberance and Panic Buying Risk Index
Slower average house price growth through 2016, compared to 2014 and 2015, coupled to gradually rising Prime rate through 2014 to early-2016, has served to maintain a positive Real Alternative Prime Rate, which has lowered any risk of widespread speculation, over-exuberance and 1st Time Buyer Panic. The FNB House Price Indices remained firmly in singledigit territory through 2016, while Prime Rate is in double digits.
5. HOME AFFORDABILITY RISK – RATING: 6.26 - HIGH
The rationale: The risk of downward pressure on house prices, in the event of an economic shock or interest rate hiking, is heightened the less affordable a residential market becomes. We consider 3 main types of affordability. Firstly, the average house price relative to income is important. Secondly, house prices relative to rental costs are important, because if home values are very high relative to rental, rental may become an attractive option, lowering home buying demand. Thirdly, house prices relative to prices of consumer items are also important, because these compete with housing for a slice of the household income pie, and housing needs to be “competitively priced” in this regard. The higher the house prices relative to these other variables, the less price competitive housing becomes and the higher the Affordability Risk.
The compilation of the Housing Affordability Risk Index
The Housing Affordability Risk Index is compiled from 3 affordability indices:
- The Average House Price/Average Employee Remuneration Index.
- The Average House Price/Average Rental Index
- The Average House Price/Consumer Prices Index
In all 3 sub-index cases, the higher the index level, the worse the affordability, or the less price competitive housing is, andthe higher the affordability risk becomes.
The Index: Home Affordability Risk remains high, but no longer rising
The Composite Home Affordability Risk Index was on a broadly rising (deteriorating) trend since 2012 to late-2015. However, after reaching a multi-year high of 6.31 in the final quarter of 2015, it has declined (improved) very slightly to 6.26 by the 3rd quarter of 2016.
The key drivers in recent trends in Home Affordability Risk
The Average House Price/Per Capita Income Index is the lowest of the 3 affordability sub-indices, due to significant average wage inflation over recent years, which outpaced average house price inflation for much of the time since 2008.This index recorded a level of 4.76 (scale of 0 to 10) in the 3rd quarter of 2016. The Price-Rent Ratio Risk Index at 7.0, and the Real House Price Risk Index at 6.99, keep the Affordability and Price Competitiveness Risk in the “High Risk” zone though.
COMPOSITE HOUSING MARKET RISK– RATING: 29.36 - MEDIUM
The Composite Housing Market Risk Index includes the following risk sub-indices:
- Household Debt-Service Risk Index
- Household Sector Savings Risk
- Disposable Income Windfall Risk
- Residential Property Speculative, Over-Exuberance and Panic Risk
- Housing Affordability Risk
- New Building Oversupply Risk
This Composite Index attempts to capture Household Sector Financial and Housing Market-specific conditions and risks, excluding mounting economic risks which are later captured in the Macroeconomic and Current Economic Pressures Indices.
The Composite Housing Market Risk Index has declined (improved) noticeably in 2016, from a multi-year high of 33.45 in the 3rd quarter of 2015, to 29.36 by the 3rd quarter of 2016. This is the best (lowest) rating since the final quarter of 2009, and is in the lower half of the “Medium Risk” zone.
7. MACRO-ECONOMIC RISK– RATING: 7.92 - HIGH
The rationale: Risks to Macroeconomic performance are key to the housing market, as it is the economy that drives employment and household income growth. The risks are very much determined by to what extent the country is living, or not living within its means, as reflected in the Current Account Balance. They are further determined by the scope that the Monetary and Fiscal Authorities have for future stimulus. This is determined by the current level of real interest rates (low implying less scope than high current real rates) and the Government Debt-to-GDP Ratio. Finally, current economic growth is key, as low growth has the potential to dent investor confidence (and thus future growth) as well as to fuel social tensions and economic disruptions in future. As a key Global Risk indicator we’ve included US 10-year Government Bond Yields, the lower the yield the higher the global risk.
The compilation of the Macroeconomic Risk Index
The Macroeconomic Risk Index is compiled from 4 key economic indicators:
- Real year-on-year GDP growth (smoothed)
- Current Account Balance as a percentage of GDP (smoothed)
- Real Interest Rates (as per our Prime Rate adjusted with the 5-year average consumer inflation measure)
- General Government Debt-to-GDP Ratio
- US 10-year Government Bond Yields
The Index: Macroeconomic Risk remains extremely high
The Macroeconomic Risk Index remains at extremely high levels. In the 3rd quarter of 2016, this Risk rating rose to a multi-decade high of 7.92, from the 2nd quarter’s 7.8. It is firmly settled in the High Risk Zone.
Key Drivers of Macroeconomic Risk
The key driver of Macroeconomic Risk’s rise has been a steadily rising General Government Debt-to-GDP Ratio, which reached 50.9% in the 3rd quarter of 2016, the highest level over the past 3-and-a-half decades over which the risk indices are constructed.
This, coupled with still moderate real interest rate levels, means very limited scope for monetary and fiscal stimulus, especiall at a time when a 4.1% of GDP Current Account Deficit already reflects a country living well beyond its means.
In addition, the multi-year stagnation in GDP (Gross Domestic Product) growth has driven this risk rating higher. The longer that growth remains stagnant, so the risk of further loss of investor confidence, as well as rising social tensions and increased economic disruption, increases.
8. CURRENT ECONOMIC PRESSURES – RATING: 6.49 - MEDIUM
The rationale: Finally, we add current economic pressures, which may not necessarily be due to the imbalances mentioned in the previous section, but rather often due to cyclical forces such as global economic strength/weakness or commodity prices.
These pressures nevertheless need to be taken into account, as they can exert near term influence on the residential market.
- The compilation of the Current Economic Pressures Index
- The Current Economic Pressures Index uses one variable, namely the OECD Leading Business Cycle Indicator for South Africa.
The Index: Current Economic Pressures remain high
The Current Economic Pressures Index remains in the High Risk Zone, and rose significantly in the 3rd quarter of 2016 to 6.49, from the previous quarter’s 6.3. This is the highest level since the 2nd quarter of 2010. There are encouraging signs from 4th quarter 2016 data that this index may turn lower in the near term, however, including improved rainfall alleviating drought conditions, and an improved global economy and commodity prices. But for the time being growth remains very weak.
Key Drivers of Current Economic Pressures
The OECD :Leading Business Cycle Indicator, a useful leading indicator of likely near term economic performance, has been in year-on-year decline for much of the period since 2014, with the most recent rate of decline for the 3rd quarter of 2016 measuring -1.03%. This quarterly rate of decline is slightly less significant than the prior quarter’s rate.
An improved Global Economy and higher commodity prices may just be starting to moderate the pace of year-on-year decline, and this decline may have even turned to increase in the 4th quarter (when final data is available). However, while signs of economic improvement may be building, the outlook is nevertheless for a weak economy at best.
COMPOSITE HOUSEHOLD SECTOR, RESIDENTIAL MARKET AND ECONOMIC RISK RATING – RATING: 16.98 - MEDIUM
Finally, we compile the Composite Household Sector, Residential Market and Economic Risk rating. This index rolls up all 3 of the Major Composite Sub-Indices, namely the Composite Household Sector and Housing Market Vulnerability Risk Index, the Macroeconomic Risk Index and the Current Economic Pressures Index, into one overall risk rating for the Residential Market.
This Composite Index has been declining (improving) from a multi-year high of 17.89 in the final quarter of 2015 to 16.98 by the 3rd quarter of 2016. It is now slightly within the “Medium Risk” zone, but still on the high side.
2 of the 3 of the Major Composite Sub-Indices have contributed negatively (i.e. exerted upward pressure) to this overall index’s level. These were the Macroeconomic Risk and Current Economic Pressures Indices. However, the Composite Housing Market Risk Index, offset these negatives, taking the Overall Risk Index lower and moving it just into Medium Risk territory.
Source: John Loos - First National Bank (FNB)
Courtesy: The Agent - Estate Agency Affairs Board (EAAB)