Research

FNB: SA Housing Market more prone to 'bubbles' than the Motor Vehicle Market

Of the major Household Sector-related expenditure items, motor vehicle purchases and homes are the big credit-dependent items and thus the most sensitive to largely monetary policy-driven interest rate fluctuations. But 3 key differences between the Vehicle and Residential market mean that the Vehicle Sector is far less susceptible to “crazy or irrational” behavior and market “overshoots”, or “bubbles”, than the Housing Market.

In the late-1990s, a sharp downward move in interest rates started late in 1998, from a Prime Rate in 25.5%, declining all the way to 14.5% by January 2000. Then, after a brief hiking period in 2002, a further decline to 10.5% Prime Rate by April 2005 ensued. At the time, the South African economy was already experiencing reasonably good growth, as it benefited from the early-1990s end to the boycotts and international isolation, and was in the process of normalizing trade and business relations with the rest of the world. Lower interest rates would strengthen the economy even more

Given that Household indebtedness levels, as measured by the Debt-to-Disposable Income Ratio, were far lower early last decade than they are today, a massive boom in demand began for both residential properties along with motor vehicles, both heavily credit-dependent areas of purchase. This broad boom period had its early-beginnings in 1999, and lasted all the way to 2007.

The 1999-2007 Boom period – similar demand surges, but very different price outcomes

Whereas the Housing Market experienced rampant double-digit price inflation, Vehicle price inflation remained subdued. The Motor Vehicle CPI actually entered a period of price deflation by 2004, at least according to the CPI numbers, and as at the 1st quarter of 2005 measured -1.6% year-on-year decline. By comparison, the Housing Market was experiencing something very different. The massive demand surge had exposed its supply-side limits, and the FNB House Price Index inflation rate had shot up to 36% year-on-year by the 1st quarter of 2005.

Price “bubbles”, where price levels deviate significantly from the underlying “economic fundamentals” can be a major source of financial stress for the market participants, and when the bubbles burst they can bring about major “systemic risk” in the Financial Sector. As such, they are seen as undesirable.

Our recent history suggests that the Housing Market is far more susceptible to extreme house price inflation than the Motor Vehicle Sector. The question is why? Both industries are similar to each other in terms of being strongly Household Sector demand-driven, both items being relatively large infrequent purchases for most households, and both being heavily dependent on credit to finance purchases.

Admittedly, in good economic times and cheap credit environments, there exists the possibility that both the highly credit driven Vehicle and Housing Markets can “overshoot” due to a general high level of Consumer Confidence that can get to a level of “General Over-Confidence”. Vehicle markets can also conceivably have significant price surges on the back of shocks to imported vehicle and component costs.

But the Housing Market has something extra, which leads to its greater propensity to achieve “bubble” levels, overshooting by a far greater magnitude, or so we believe.

While there are no doubt many differences, we ascribe the seemingly big difference in the propensity to experience “price bubble” behavior, between the two markets, to 3 key differences in “market or product characteristics”.

1. The Supply Side of the 2 Markets

Firstly, the Residential Market has a more significant constraint of supply of new residential stock in the short term, compared with that of the Vehicle Sector, and in times of extreme growth in housing demand that can lead to rampant house price inflation. Achieving high vehicle price inflation during last decade’s boom years was always going to be far more difficult in a market where supply of new vehicles could be ramped up far more rapidly than could the supply of new housing, either by raising local manufacturing output or by importing.

2. South Africa’s obsession with home ownership and regarding a home as an investment

Secondly, high price inflation in the housing market, which initially emanated from strong demand growth as the boom times began, then encouraged further growth in demand as speculators, and panicky 1st time buyers obsessed with owning a home before it became too expensive, flocked to the market. Add to this a widespread view in South Africa that a home is an investment, and amongst less experienced investors the notion that times of high price inflation are the times to buy (often an incorrect view), and you have the recipe for a house price “bubble”. Motor vehicles, in contrast, are seen as consumer goods rather than as an investment, although in a country with a lack of public transport they are also seen as crucial to own by the Middle Class.

3. Unlike Motor Vehicle Price inflation, House Price inflation is not a direct target of monetary policy

Finally, a 3rd key difference between the 2 markets is the fact that motor vehicle prices are included in the CPI, making them a direct target of the SARB’s monetary policy regime. Should motor vehicle price inflation surge to the extent that house price inflation did back around 2004/5, there is a greater likelihood that the SARB may have acted by hiking interest rates, given that such a price inflation surge would exert upward pressure on the overall CPI inflation rate, the target variable of the SARB.

So, while a price bubble can never be ruled out in the Vehicle Market, should supply become constrained for some reason and rampant price inflation follow, a less constrained short term supply capability in the New Vehicle Market, compared to homes, it becomes far more difficult for that market to achieve this. The way the public view a home, i.e. as an “investment”, versus viewing a vehicle as a consumer good, can add “fuel” to the fire, and in a CPI inflation targeting regime there is a greater likelihood of a vehicle price inflation surge being curtailed by monetary policy than there is of a house price surge.

Given the consequences of housing price bubbles to Financial Sectors, Household Sectors and Economies in general, as witnessed after last decade’s Global housing bubbles in many countries burst, the question has often been asked as to whether asset prices such as house prices should not also perhaps be a direct target of interest rate policy.

Read more here: FNB Property Weekly 3 Nov 2015