New homebuilding prospects waning again
15-12-2010
It is easy to understand why building activity tends to track house prices. It has to do with demand and supply, and the profit margin of developers. Economists call it the price mechanism. In a free market, a deficit of supply relative to demand results in price increases, which pushes up the potential profit margin of developers, which triggers new supply, courtesy self-interested developers.
This phenomenon is graphically illustrated in the chart below. Note the high correlation between changes in prices of houses and changes in building plans passed (a precursor of new supply). House prices reached a nadir in the beginning of 2009, but thereafter rallied quite impressively, presumably on the back of speculators who were picking up distressed properties at depressed prices. This unfortunately led a minority of developers to believe things were returning to normal. Thus, the growth in the volume of residential-building-plans passed tracked the surprise jump in house prices. And even though the growth in house prices have by now turned sharply down, building plans are still pointing northward.
We hope for the sake of these opportunistic developers that they didn’t convert their building plans to houses completed.
From a supply and demand perspective, however, the likelihood of continued weak residential building activity might just prove to be the saving grace for the market values of existing homes. This is especially so since falling interest rates have, thus far, not led to significant improvements in the effective demand for housing.
Affordability of houses, of course, remains the biggest constraint to effective demand. Here one only has to consider the effect of the National Credit Act, the still-high levels of real house prices, job uncertainty, the high indebtedness of consumers and fast rising electricity tariffs. In addition, taxpayers seem to be facing income-tax hikes next year (if only through bracket creep); not to mention the ongoing escalation of assessment rates in many municipalities; after all, someone has to pay for incompetence (euphemistically called lack of capacity).
