The issues of comparing housing affordability between regions

Housing markets are incredibly important, not only due to the importance of formal housing to citizens’ well-being, but also due to the huge amounts of mortgage debt associated with them, and the various risks that this can pose to financial system and economic stability. The result is that house price data is used for many types of analysis, with some of these types of analysis and the conclusions drawn being hazardous at best.

One of these “hazardous” uses of house price data is making “macro” house price or affordability comparisons between regions or countries with the aim of ascertaining which market may be the strongest/weakest or most “overheated” and thus most at risk of “correction”.

Many comparisons between regions are flawed, because they simply don’t take into account the differing structural characteristics between regions. The fact that UK average house prices are far higher in Rand terms than South African house prices says nothing about whether the South African market is “under- or over-valued”. The UK has far higher average income levels, and a far greater land scarcity, which should mean higher home values over the long term than in a developing country such as South Africa.

Between countries, different currencies also complicate our ability to compare house price levels with the aim of evaluating who is relatively “undervalued” or “overvalued”, because currencies can fluctuate wildly and move to levels far from purchasing power parity.

But analysing affordability between regions even within the same currency area is an inexact science. Average price levels alone say little about comparative home affordability between regions, or about whether a specific market is more “overvalued” or “undervalued” than another. House Prices relative to some form of purchasing power measure such as income is required. But due to structural differences between regions, even this doesn’t prove anything about the extent of “over”- or “under- valuation” in a region. Let’s take the Major 4 South African provinces, for instance. It may surprise some to hear that the Western Cape is not the least affordable housing market for all of its own inhabitants. Despite having the highest regional average house price, the province also has the 2nd highest Per Capita Income after Gauteng. Using the Average House Price/Per Capita Income Ratio as a measure of home affordability, Gauteng is the most affordable Big 4 province with a ratio of 13.94 (as at 2015, with provincial Per Capita Income data for 2016 not yet available), the Western Cape 2nd most affordable at 17.81, KZN on 23.17, and the Eastern Cape the least affordable by this measure with a ratio of 24.12.

KZN and the Eastern Cape thus have significantly worse affordability measures than Gauteng and the Western Cape. However, this is due to their low Per Capita Incomes rather than due to high house prices. However, from this one can absolutely not draw the conclusion that the Eastern Cape is the most “overvalued” and thus the most at risk of a price “correction”. Rather, it probably reflects a larger portion of the Eastern Cape’s households living outside of the highly-traded “mainstream” formal housing market, due to their incomes being too low. And these households can live outside of the formally traded housing market on an indefinite basis, with the supply of housing adapted to this situation, without needing to suffer a major correction in prices.

So how does FNB compare regions? The best they can do is to evaluate a market against itself over time. In other words, which region’s affordability has changed the most or the least? Then, the relative trends in the regions’ affordability measures can be useful.

From 2010 to the present, FNB are of the opinion that the Western Cape’s housing market has become the most “over-heated” relative to the other major South African regions, despite its House Price/Per Capita Income Ratio being the 2nd lowest of the major provinces.

Their approach is firstly to examine cumulative house price inflation, where the Western Cape has out-paced other regions significantly. This has caused the province’s Average House Price/Per Capita Income Ratio to deteriorate (rise) more than those ratios in the other major provinces, from 2010 to 2015 (2016 income data not yet available).

The Western Cape Home Affordability Ratio (Average House Price/Per Capita Income Ratio) had risen from 15.4 in 2011 to 17.8 in 2015. Over the same period, the Gauteng ratio had deteriorated (risen) to a lesser degree, from 12.3 to 13.9. The KZN ratio on the other hand had declined (improved) from 24.8 to 23.2, and the Eastern Cape had also improved (declined) from 25.6 to 24.1.

Whilst FNB does not yet have 2016 Per Capita Income data, Western Cape Average House Price growth strengthened to 9.4% in 2016, from 2015’s 9.2%, while the next strongest growth rate was KZN with 3.1%, Gauteng 2.1% and Eastern Cape 1.8%. This suggests that the Western Cape’s Affordability Ratio probably deteriorated more than the others once again in 2016.

FNB then likes to view certain non-house price-related indicators for further signs of a region’s possible home affordability deterioration, for those groups who are normal candidates for the mainstream housing market. FNB believes they have found a key indicator which indeed points to the Western Cape housing market having become significantly less affordable for its local “clientele” in recent years.

This indicator emanates from our FNB Estate Agent Survey, and relates to the agents’ perceived levels of first time buying. first time buyers are on average younger buyers, and more financially constrained than many older repeat buyers who have built up equity in their homes that they sell in order to purchase another home.

Averaging the 2 summer 2016/17 quarters’ survey results, in order to enhance sample size by city, we indeed find the City of Cape Town to have by far the lowest estimated number of 1st time buyers expressed as a percentage of total home buyers, to the tune of 8%. This is far below Joburg’s 27%, Tshwane’s 21% and Nelson Mandela Bay’s 22%. Even Ethekwini’s mediocre estimate of 14% is significantly higher.

It was from around 2010 that the City of Cape Town (and indeed the Western Cape), began to outperform the national average in terms of house price inflation. Cumulatively, over the past 7 years up until the 1st quarter of 2017, the Western Cape’s average house price growth of 75.8 has outpaced all the other major regions, the 44.5% rate for KZN being the next strongest over the period.

So it was probably no co-incidence that it was also from around 2010 that the 1st time buyer percentage estimate for Cape Town began to noticeably under perform the national average.

The FNB first time buying estimates by major city thus appear to reflect a more significant affordability deterioration for local residents of Cape Town, compared to other major cities.

FNB attempts to back this up further with estimates of the average age of home buyer by province. Structurally, the age demographics can mean that a province can have a permanently older average age of home buyer without this implying anything about relative affordability.

However, since around 2012, in a relatively short space of time, FNB have seen the Western Cape’s average age of home buyer rise markedly faster than the rest of the major provinces, to open up a gap on the rest of the provinces, its average age being 45.64 years for the 4 quarters up to the 1st quarter of 2017. The next oldest average age was for the Eastern Cape, i.e. 44.26 years. The province with the youngest average age of home buyer over the period was Gauteng, at 41.2 years, which is possibly reflective of that province having the best affordability.

From this, FNB deduces that the Western Cape’s affordability challenges, for its inhabitants who are “normal” candidates for the “mainstream” formal housing market, have become more pressing in recent years relative to the other provinces. In contrast, arguably faring the best in terms of affordability for its inhabitants is Gauteng, taking all of the indicators into account. Gauteng has the highest Per Capita Income, which is key to it having the lowest Average House Price/Per Capita Income Ratio despite having the 2nd highest average house price of the major regions. It has had some mild Average House Price/Per Capita Income rise (affordability deterioration) since 2010. But viewing non-price-related indicators, the province has the highest 1st time buyer estimates in recent times, and continues to have the youngest estimated average age of home buyers too. This relatively good affordability situation in Gauteng is one important factor in attracting the young skilled labour that is required to maintain the region’s status as the number one economy, in terms of both sheer size as well as long term growth.

The approach to comparing the price strength and affordability levels between regional markets thus has to be a multi-faceted one, evaluating not only trends in standard affordability measures, but also viewing non-price-related data to assess whether behavior in the market reflects affordability changes and mounting challenges.

Read more here: FNB Property Barometer – Hazards of Regional Affordability Comparisons – June 2017