Property Barometer – Residential Market Vulnerability Risk Review

Progress in the lowering or residential market vulnerability is slow but it has been occurring 

The risks to the future stability of the housing market improved (declined) mildly during the fourth quarter of 2017, resuming a gradual declining trend that has been taking place since 2015.

Household Sector and Housing Market-specific risk declines (improves) slightly

On the household sector side, the ongoing decline in the Household Sector Debt-to-Disposable Income Ratio remains a positive development in terms of lowering the household sector’s and housing market’s vulnerability to unwanted economic and interest rate shocks. The Debt-to-Disposable Income Ratio has declined all the way from 87.8 as at the first quarter of 2008 to 71.2 by the fouth quarter of 2017. Given that much of this overall 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.

Largely as a result of this multi-year decline in the Debt-to-Disposable Income Ratio, the all-important Household Debt-Service Risk Sub-Index is down in “Medium Risk” territory, from being well up in the High Risk zone a decade ago (each risk index having a “High Risk”, Medium Risk”’ and “Low Risk” Zone).

Within the Household Sector and Housing Market, there are certain sub-indices which remain in “High Risk” territory. Notable here is the ongoing dismal state of Household Sector Savings, which although improved from a few years ago remains at very low levels not conducive to building up strong financial “buffers”. In addition, Housing Market Affordability Risk remains high, with real house price levels in South Africa still high by historic standards.

However, key positive (low) risk contributors relate to constrained new housing supply and a lack of any risk of speculative or “over-exuberant” behavior in the market. Speculators try to take advantage of cheap credit and a strong price growth trend. There is little of the latter, with house price growth firmly rooted in single-digit territory and, importantly, well-below the mortgage borrowing rate. Disposable Income growth remains moderate too, despite some recent strengthening, so there is little risk of “over-exuberant” home buying and investment that can often arise in times of major household income “windfalls”.

With regard to new housing supply, a positive risk factor is that the Residential Development Sector remains subdued due to the cost of building new homes being significantly higher than the average price of existing homes.

Overall, taking the above factors into account, the Composite Household Sector and Housing Market Risk Index is placed firmly within the “Medium Risk” zone.

It declined (improved) slightly in the fourth quarter of 2017 to 31.80 (scale of 0 to 60), from 31.95 in the prior quarter, but for all intents and purposes has moved sideways through 2017, ending the year at the same level that it recorded at the start.

Despite no improvement from start to finish of 2017, the index level remains sharply improved since the all-time high (worst) risk level of 46.389 reached in mid-2006 at the height of the pre-2008 housing bubble.

But the broader economy is where the big risks still lie

The state of the country’s broader economy is where the very significant risks to the housing market still linger, despite a noticeable improvement in sentiment in the country following the change in Presidents of both the ruling party and of the country.

Economic growth has improved mildly from early-2016 to late 2017, but remains stagnant at 1.5% year-on-year as at the final quarter of 2017. More positive sentiment since early in the year is welcome, but the country’s policy direction remains uncertain, and with weak economic growth continuing, this sustains the risk of elevated social tensions, greater instability and economic disruption. FNB has witnessed steadily rising government indebtedness over the past decade, with the Government Debt-to-GDP Ratio reaching 53% in the fourth quarter of 2017, its highest level in the three-and-a-half decades over which the risk indices are compiled. This, along with relatively low real interest rates, points to limited fiscal and monetary stimulus potential for the economy at present. One macro-economic risk improvement in recent times has come in the form of a noticeable narrowing in the Current Account Deficit on the Balance of Payments, from as wide as -6.9% of GDP in the third quarter of 2013 to -2.9% in the fourth quarter of 2017. This reflects a country living less beyond its means of late. However, the most recent deficit remains significant.

This weak growth economy therefore remains a “high risk” one, and these broader macroeconomic risks still pose a key risk to the level of future residential demand and thus the housing market’s health and stability. The Macroeconomic Risk Index did decline in the fourth quarter of 2017 from 7.45 previous to 7.36, but it remains rooted firmly in the “High Risk” zone.

Current Economic Pressures Risk subsides (improves) in the fourth quarter of 2017

Although economic growth remains weak, the SARB and OECD Leading Business Cycle Indicators for South Africa have recently been rising, pointing to the possibility of slightly better economic growth to come in the near term. This has meant that our Current Economic Pressures Risk Index subsided in the 4th quarter of 2017, thus making it a mildly positive contributor to the broader Housing Market Risk picture. Therefore, while the big Macroeconomic imbalances, as reflected in the Macroeconomic Risk Index, are a key negative to overall housing market stability, near term cyclical economic risks appear to have been alleviated somewhat, and remain in “Medium Risk” territory at a level of 5.48 in the fourth quarter of 2017, down from 5.80 in the prior quarter.

With global economic performance still reasonably solid, improved growth performance for South Africa is plausible. It is especially possible given that FNB has seen some improvement in sentiment in and towards South Africa, feeding into an improved 1st quarter RMB-BER Business Confidence Index. The political leadership change recently has been key in boosting sentiment.

Against this, however, the Western and Eastern Cape droughts remain intact, and can hamper economic performance in those regions especially via the impact on agriculture.

Nevertheless, FNB projects an economic growth rate of 1.8% for 2018, slightly above the 1.3% actual number for 2017, therefore stronger than last year but still weak.

The Composite Housing Market Vulnerability Index thus declined (improved) in the fourth quarter of 2017, thanks to quarterly declines in the Composite Household Sector and Housing Market Risk Index, in the Macroeconomic Risk Index as well as in the Current Economic Pressures Risk Index.

The Index saw a decline (improvement) from 17.39 (Scale of 0 to 30) in the previous quarter to 17.19 in the fourth quarter of 2017. This level is now noticeably lower (better) than the multi-year high of 18.18 reached at the end of 2016, and well down on the all-time high of 20.06 reached at a stage of 2006.

In short, there has been gradual progress in lowering risk as reflected in the Composite Housing Market Vulnerability Index, since 2015. This index remains vastly improved since the all-time high (worst) of 20.06 reached at a stage early in 2006, due to major improvements within the household sector and housing market since then. But it could be significantly lower today if not for high levels of Macroeconomic Risk. The Macroeconomic Risk Index, has started to move slightly lower (better) recently, but remains in the “High Risk” zone, implying that the most significant risks to the housing market thus emanate more from outside of the market, and relate to the broader economy.

Read more here: FNB Property Barometer – Residential Market Macro Stability Review – 28 March 2018