Priceless. Only relative prices matter. (The Bugle)

“Priceless. The myth of fair value.” The title of a fascinating book by William Poundstone investigates the hidden psychology of value. The back sleeve of the book reads: “People used to download music for free – then Steve Jobs convinced them to pay for it. How? By charging 99 cents. Prada and other luxury stores stock a few obscenely expensive items – just to make the rest of their inventory seem like a bargain. Why do text messages cost money, while emails are free? Why do jars of peanut butter keep getting smaller in order to keep the price the same? The answer is simple: prices are a collective hallucination.” 

The author takes you on a detailed journey of research into behavioural decision theory. It is a place where psychology and economics interact and demonstrates how pricing of everything and anything directly affects our relative value we ascribe to it. The thesis of this research is that we really do not ever understand the absolute pricing of anything, real estate included, but only the relative price of a good, service or product (or home) relative to other comparables. The idea of “anchoring” our perception of value is explained by the author, where quoted prices become the relative benchmark and discounting from these benchmarks then begins to create a relative perception of value in our own minds.  

The book has two chapters on real estate and explains the details of an interesting experiment conducted in Arizona on how people respond to the perceived value of a home, based on its listed price. An interesting question to ask your real estate agent, assuming he or she is impeccably honest, is what would you price my home at, if it was your own?  What is realistic pricing in any given market? It is always relative to other similar properties, and if the property is truly unique (almost never), then the comparison is to what the next best use of the money would be to the buyer. What Poundstone investigates in his book is to what extent can our perception of value be manipulated by the quoted prices we are confronted with. Despite us all thinking we are too smart to be tricked into believing a certain product has value at a prescribed price, all you have to do is watch one of the Verimark commercials to see these pricing psychology techniques at work, where pricing comparatives are quoted over and over and small additions are added to the product to make it seem so much bigger an offer than it actually is. And just when you thought they would put an end to the agony of enduring the sales pitch, you hear the words, “and that is not all…”. So does it work? Retail consultants would confirm that it does. 

This then begs the question as to what extent can the same method be used in pricing and selling real estate? Having had the experience of two decades worth of actively marketing and selling high end residential property, my view is that the anchoring technique described by Poundstone does in fact work – the value we ascribe to a property is influenced by its list price and by the pricing of comparables. Two measures of pricing realism, for residential properties, are (1.) the average time on the market and (2.) the percentage of properties sold at less than their asking price. For the 4-quarters up until 1^st quarter of 2013, the average estimated time of homes on the market, as measured by FNB, for the lower and middle income segments was 13,6 weeks and 14,5 weeks respectively. The upper income and high net worth segments recorded 17,8 weeks and 19,6 weeks respectively. The percentage of properties sold at less than their asking price, across these four categories were: Lower income (80,3%), Middle income (86,5%), Upper income (91,3%) and High net worth (83,5%). These figures indicate rampant over-pricing or a low level of price realism, which is more pronounced at the higher price end of the spectrum.

(Author: Andreas Wassenaar, published in The Bugle, 24 Feb 2013)

The Additions & Alterations Market (The Bugle)

Last week we looked at residential building activity and this week we will focus on the additions and alterations market for residential properties. When times become financially tough, as experienced from 2008 onwards, the behaviour of property owner’s changes in terms of how much money they spend on maintaining their homes. As every property owner knows and understands,  continual maintenance and care is required for a property. If this is neglected the property soon becomes run down. It is interesting to note that the size of the residential additions and alterations market as measured by the square metres of projects completed was 1,47m in 2012, which was 16.8% down on the 2011 figure of 1,76m, which in turn was down by 2.7% on the 2010 figure of 1,81m. The 2010 figure was already a large reduction of 21.6% on the prior year. These figures clearly indicate that consistently less has been spent on additions and alterations over the past four years. If we look at building plans passed for additions and alterations over the same period, we see that in 2012 a total of 3,12m square metres was passed, in 2011 we had 3,16m square metres passed and in 2010,  3,44m square metres was passed. You would immediately note the large difference between plans being approved and actual projects completed. For the last three years this gap between plans approved but actual building completed, measured in square metres, amounted to 1,63m for 2010 (or 47,4% of actual approved plans), 1,40m for 2011 (or 44,2%) and 1,66m for 2012 (or 53,1%). This indicates that approximately half of all approved plans are not actually built.  One explanation is that once the cost of the addition or alteration is calculated, it is typically higher than expected and the project is put on hold.

Local authorities would be interested in this statistic as they typically spend a lot of time approving plans of projects that will never see the light of day. Building service providers, such as contractors or architects, who can provide their clients with detailed cost estimates prior to doing any design work, should be well received in the market place and should eliminate wasted costs associated with projects that do not go ahead. It makes perfect sense therefore for an architect to charge approximately 75% of the overall design fee prior to a spade going into the ground. The published report by FNB on the renovations market used a survey to measure the market in terms of five broad categories of home maintenance. The results from the January 2013 survey indicate that 3% of home owners fall into the category “letting their homes get run down”, 10% only “attending to basic maintenance”, 38% “fully maintaining their homes” , 45% “maintaining fully and making some improvements” and only 3% making “value adding upgrades”. The positive news is that there has been a big decline in the overall percentage of home owners in the bottom two categories, letting their homes get run down and attending to basic maintenance only, from 38% in November 2008 to 13% by the 1^st quarter of 2013. The majority of homeowners (73%) are now in the “full maintenance” and “full maintenance with some improvements” categories. We still however have a way to go before any serious level of value adding improvements are to be undertaken.

(Author: Andreas Wassenaar, published in The Bugle, 17 Feb 2013)

Debt Service Risk (The Ballito Mag)

If you are a property owner and would like to have a clear understanding of when best to buy or sell, there are certain key macro-economic trends to keep a careful watch over. The micro-elements we as sellers have control over relate to the presentation and quality of the property and the marketing over the seasonally best time of the year. Timing a sale is more important in areas with large seasonal climate variations, such as Gauteng and Cape Town, and less important in areas with low seasonal climate variations, such as KZN. Many would claim that selling a property in May in KZN, especially along the coastal regions, is in fact better than mid-summer. These aspects can have a significant impact on the salability of any particular home, but the general market trend and cycle have an arguably more profound impact. Buyers are best equipped to commit to a property when they have access to readily available mortgage funds, when the cost of this is relatively low, when they have the capacity to take on and service debt and when they are feeling up-beat and confident about their future prospects. Economists measure these drivers of buyer behavior and report them as GDP growth as a measure of general economic activity, residential mortgage credit growth, the prime interest rate, the household debt and disposable income ratios and the household sector debt service risk index. Considering the measurements of these key statistics provides us with excellent insight into the state of the property market and what can reasonably be expected within the medium term.

Hot of the press is the FNB published analysis of the household sector debt-service risk index. This index measures, on a scale of 1 to 10, the vulnerability of the country’s household sector when it comes to being able to service its debt in the future. This brilliant predictor of the financial resilience of households is compiled from the household debt-to-disposable income ratio, the trend in the debt-to-disposable income ratio, and the level of interest rates relative to the long term average consumer price inflation. As you can imagine the higher an individual’s (or the country’s household sector as a whole) debt-to-disposable income ratio, the more vulnerable the individual or household sector is to unwanted “shocks” such as an interest rate hike or downward pressure on disposable income due to unemployment or declining economic activity. The 4^th quarter measurement of this index is 6.55 which remains high relative to the long term average of 5.2. It remains high largely because the indebtedness risk of households remains high. This remains high because our overall household debt-to-disposable income remains high at 75.8%. Interest rates remain at historical low levels with the prime interest rate at 8.5%, down from its more recent peak of 15.5% in 2008. When interest rates are low however, the risk is that they will increase making households more vulnerable. FNB predict that interest rates have room to move upwards, but caution that any increase above 12% would be met with severe financial pain given the current household debt levels.

As a property professional, what has fascinated me is the change in household credit growth. Residential mortgage credit growth and non-mortgage household credit growth moved predictably in tandem from 2002. However, from January 2010 the growth in non-mortgage credit growth has been exponential and is currently at 23.29%, while mortgage credit growth has declined to the lowest levels over the same period and are currently 1.25%. This alarming growth in unsecured lending, with banks such as African Bank and Capitec leading the charge, has been severely criticized by economists and government alike. In a Financial Mail lead story published on 14 Feb 2013, the question was raised on the sustainability of African Bank’s business model and reported that the National Credit Regulator had made an allegation of reckless lending against African Bank and requested that the Consumer Tribunal fine the company R300m. Finance Minister Pravin Gordhan is equally concerned about the low rate of mortgage growth, which is viewed as lower risk positive lending as it finances assets that tend to grow in value over time, while at the same time witnessing the more risky unsecured lending growth. Gordhan has reportedly engaged with the banking sector to discuss these issues. This is important as mortgage growth underpins the residential property market.

(Author: Andreas Wassenaar, published in The Ballito, April 2013)

Residential Building on the up (The Bugle)

Residential building activity has been through a tough few years recently. The most recent information released by StatsSA indicates that 2013 is off to a good start with the January 2013 year-on-year square metreage of residential buildings completed rising by 10.4%. As monthly figures can be volatile, the three-month moving average is a better indicator of a trend and this figure for the three months to end January also indicates a healthy 9.9% year-on-year growth. A full recovery in this building segment is some way off but there are signs that we are moving in the right direction, which will be good news for all those contractors and suppliers to the residential property market. 

To get an understanding of how much pressure the residential building market has been under two important statistics can be considered: Square metres of residential building plans passed and square metres of residential buildings completed.  In 2012 the total building plans passed was 5,8m square metres. This was a decline of 7.9% on the 2011 figure of 6,3m square metres. However the 4^th quarter of 2012 indicated an improvement of 13.3% on the previous quarter and this is a positive sign for the near future as building plans passed is a good leading indicator of actual building activity and buildings completed. The actual square metreage of residential buildings completed in 2012 was 3,5m, a large decline of 25.4% on the 4,7m recorded for 2011. The figure for 2010 was 4,8m, which was a 28.3% decline in completions from the previous year. This type of consistent decline in residential completions translates into a shrinking industry of contractors and suppliers that service this market. Their margins would have been squeezed to almost nothing at which stage many make the decision to close shop rather that keep on building only to pay staff wages and keep the operation open in anticipation of better times ahead. The positive news is that the fourth quarter 2012 completions figure was a positive 5% on the previous quarter. 

The cost of a newly built home relative to the cost of buying an existing property is a key statistic produced by FNB and published as their Full Title Property Replacement Cost Gap. Very rarely will this figure ever be zero. It happened briefly in 2007, which underpinned the peak of the building boom at that stage making it very easy for developers of new homes to compete on price with existing stock. The most recently released figure for the 4^th quarter 2012 shows the replacement cost gap at 21.0%, which is down from 23% in the previous quarter and an improvement on the early-2012 peak of 26.1%. This is encouraging news for developers even though a price differential of 21% between old and new remains significant, this price advantage is declining.

The average size of residential units passed and completed is currently 111 square metres, down from the 141 square metre peak of 2006. FNB reports that this declining trend in size is expected to continue, as densification of our urban areas becomes inevitable. The current composition of buildings completed indicates an almost identical split between the “Flats & Townhouses” and “Dwelling houses greater than 80 square metres” categories. The strong growth in the flats & townhouses component by 34.5% as a year-on-year figure as at January 2013 provides further evidence of renewed developer activity in the residential market.

(Author: Andreas Wassenaar, Published in The Bugle 10 April 2013)

Global House Prices (The Bugle)

If you could live anywhere in the world, where would that be? Having travelled extensively for five years between 1991 and 1995, I soon realized that most places have something really good to offer and our basic human nature tends to make us gravitate to the places where we are most familiar. This is why we find that with residential property people tend to buy and sell within a very limited geographical area – the sellers become buyers within the same area and vice versa. However, wealthy individuals are likely to own several properties around the world. They often tend to buy in areas for political reasons, such as mainland Chinese investors buying residential homes in Hong Kong, or South Africans buying in Mauritius, or for pure recreational reasons, such as German buyers buying a holiday home in Zimbali which they may use one month of the year. Everything is relative. Russians buying over-priced Dubai apartments were happy to do this as long as it provided a way of channeling undeclared money into mainstream investments. The price premium was a small price to pay. Money tends to move faster and earlier than governments are able to legislate the limitations on cross border investments. Knowing this, economists have often debated the value of exchange controls and have in fact argued that they are counter-productive. The argument for limiting the buying of South African residential properties by foreigners is as short-sighted and ill-informed as the idea of limiting foreigners from buying bonds or equities in our local financial markets. 

The fascinating Knight Frank Global House Price Index report tracks 55 housing markets around the world. The recently published report for the fourth quarter of 2012 shows that 20 of these housing markets actually fell in 2012 with 19 of these being in Europe. So where is the world’s hottest residential real estate market at the moment? Hong Kong leads the pack with property prices growing by 23.6% in 2012. This is basic economics at work. With limited supply and excess demand being generated by wealthy mainland Chinese investors, prices are being driven upwards. Dubai was logged in second place with growth of 19% in 2012. Dubai experienced significant depreciation in prices from 2008 onwards as bank finance evaporated and large development projects stalled. A strong recovery seems to be evident as sales volumes are rising and market transparency is improving. The US property prices grew by 7.3% in 2012, the largest annual rise since 2006. South Africa took position 11 on the list, just ahead of the US, with growth of 7.4%. Other winners on the list were Brazil in third spot with house price growth of 13.7%, Russia with 10.2%, Taiwan with 9.7%, China with 9.3% and India with 8.5%. Two Eurozone countries that bucked the trend in Europe were Turkey with house price growth of 10.5% and Austria with 10.1%. So who were the biggest losers? Greece fills the bottom slot on the list of 55, with a decline of -13.2%, and Spain is not far behind with a decline of -10%. The Netherlands is a somewhat surprising member of the losers club, having registered a decline of -6.3% in house prices.

(Author: Andreas Wassenaar, Published in The Bugle, 3 April 2013)