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Johannesburg - In South Africa, with its stagnating economy, the risk of underestimating the extent of future property value decline is possible, according to John Loos, household and property sector strategist at FNB.
This risk would, however, depend on how weak the economy gets before it gets better, he pointed out.
"A slowing house price index growth rate is unlikely to tell the full story of residential weakness should it occur, because such an index only records what gets transacted, and not what has 'exited' the residential market. The market price can also remain significantly above equilibrium price for lengthy periods of time," explained Loos.
This doesn’t render house price indices useless, but, in his opinion, one has to understand what you are dealing with, and what it can and cannot tell you.
"The reality is, though, that home values can and do fluctuate up and down, perhaps more than we think and more than a house price index would tell us," said Loos.
"There exists a view that property values are capable of by-and-large 'holding up' in tougher economic times, some even believing that home values “can only rise. These claims, or assumptions, around property values are often a little far fetched, and we believe that they stem, in part, from a misinterpretation of the most commonly used measures of home prices, namely house price indices."
A house price index does not measure all existing home values but, rather, transaction prices.
In his view a country such as South Africa, with its general inflation rate, should see average (nominal) house prices rising more than they fall.
The FNB House Price Index, for instance, showed only one year in its 14 year history in which the average house price for an entire year declined.
The Absa House Price Index with its 49 year history, only had three years in which the average house price for the entire year fell.
"However, in real terms, adjusting for Consumer Price Inflation over time, we find 24 such years of decline, a very different picture. Yes, 'downward corrections' are more common than many may believe," said Loos.
The average house price level, as depicted by a house price index, is not necessarily the “market equilibrium” price and a house price index is not a national home value index, he cautioned.
In toughening economic times, for instance, one can see a slump in the volume of residential transactions being more significant in more financially pressured areas.
The number of such financially pressured areas can increase in number during recessionary and stagnant economic periods.
The influence of such areas or market segments on an overall house price index can then decline, whereas stronger market segments’ transaction volumes could conceivably hold up better.
"Such 'diminished influence' of certain areas on a transaction-based index, can become more frequent in an economic downturn, raising the likelihood that a house price index can over-estimate how well residential values have held up in tougher economic times," said Loos.
"The traded market can shrink dramatically in size in such circumstances, and it is those properties still traded whose prices can hold up reasonably, but not necessarily the broader average value of all property stock."
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