There is price growth of housing, and there is house price surge – this article distinguishes between the two. We also take a look at rising steel prices and discuss what property buyers should know about increasing construction costs and housing affordability.
Malaysian policymakers and the public would do well to closely monitor developments in house prices. Not only because housing is easily the single largest investment anyone can make and any changes will affect a household’s balance sheets, but also because it has become an investment vehicle that could deliver capital gains far greater than earnings from work or other investments in the real economy.
While the pandemic-induced recession of the past two years has badly affected the global economy across the board, house prices have been surging due to increasing demands shored up by ultra-low interest rates, government stimulus, savings accrued during lockdowns, shortage in housing supply and changing lifestyles. According to the Knight Frank Global House Price Index, the proportion of housing markets witnessing annual price growth in excess of 10% sits at 48.2% in Q3 2021, compared to only 10.7% in Q1 2020 at the onset of the pandemic. (Figure 1).
Looking ahead, this global surge in house prices is expected to continue well into 2022 due to new variants permitting, higher inflations and pent-up demand from home buyers and investors. Also, the surge is expected to be fuelled by rising construction costs as a result of building materials and construction labour supply chain issues. Soaring prices of commodities such as cement, iron ore, aluminium and copper are an unstoppable global phenomenon and people are concerned about another round of house prices boom in the near future.
Rising construction costs in Malaysia and its effect on house prices
The housing market in Malaysia is likely to be affected by the rising construction costs as well, as there has been a lot of fluctuation in building material prices due to uncertainty in the supply chain for the past 12 months. According to the Real Estate and Housing Developers Association (REHDA), if the cost of construction continues to rise and builders can no longer absorb the increased costs, it will likely be passed to end-users. Since the cost of construction materials accounts for 50% to 60% of the total development value of a project, a 20% increase in construction cost will lead to a 10% rise in house prices.
Certainly, this has caused a great deal of concern over housing affordability for the people. Given that today’s households are buckling under the strains of COVID-19 due to the impact of the Omicron variant and a higher living cost that has reduced their disposable incomes, housing affordability has never been more challenging. With house prices significantly decoupling from household incomes, the government has pledged to increase the supply of affordable houses.
A panel of experts will be set up to review the existing RM300,000 ceiling price of affordable houses in Malaysia. -Ministry of Housing and Local Government (KPKT)-
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The need to distinguish between house price growth and price surge
However, simply reviewing the ceiling price without first studying the nature of the price hike would not only cause disruption in the housing market but also call into question the feasibility of building cheap enough houses for the lower-income group. This is because both locality and buildability are related to the fundamental costs of housing production. Not only do they provide insights into the ability or willingness of purchasers to pay for houses, but they also indicate the viability of kickstarting a housing project at a specific location. Furthermore, with stricter regulations, higher compliance costs and rising inflation adding to the cost of building materials, it is only logical that house prices would rise.
With this in mind, one should first distinguish between house price growth and house price surge. In general, price growth simply reflects an increase in the fundamental value of property driven by incomes, mortgage rates or other factors. This may happen due to normal house price adjustments in a healthy housing market. On the other hand, a price surge indicates current house prices are substantially higher than their fundamental values. Put simply, they are overpriced and the increment cannot be justified.
A house price surge has two components:
- imperfections in housing markets such as severe lags in supply and credit market frictions, which cause house prices to exhibit fluctuations around their fundamental values; and
- overly optimistic expectations of future house price movements and hence treated as evidence of speculation.
The price hike due to these two causes is then built into the value of new housing development projects, causing an unhealthy housing market that is subject to overheating and eventually leading to a housing bubble in the market.
Throughout the history of Malaysian house prices, a surge between 1990 to 1995 which went as high as 13.52% was clearly a result of a housing bubble. Prices within this period deviated from their fundamentals (Figure 2). While house prices continued to rise since then, no discernible bubble, or a sharp increase of prices in a short period, happened between 2000 to 2010. More importantly, income growth at 6.68% and 10.11% surpassed the rate of house prices growth (2.89% and 6.28% respectively), signifying a healthy housing market benchmarked against the overall economy throughout the decade.
House prices began to decouple from household incomes in 2010. It was especially severe from 2010 to 2015, with a compound annual growth rate (CAGR) of 10.24% in house prices against a CAGR of 1.94% in GDP per capita. Apparently, houses in the market within this period were overpriced due mainly to a lax lending policy and a positive expectation of further capital appreciation. This led to a wave of investments and transactions in the property market propagated by a speculative herd instinct, which then caused further deviation of house prices from their fundamentals.
Although house prices continued to grow from 2015 onwards, there was a gradual slowdown of pace from 7.4% in 2015 to 1.2% in 2020 (Figure 3). While the implementation of various cooling measures to curb speculation since 2014 is said to be the main contributor to the slowdown, a global economic downturn that began in early 2018 due to the US-China trade tension, followed by the pandemic-induced recession of early 2020 have badly affected the local economy, resulting in slowing demand for property and a moderate house prices growth between 2018 to 2020.
Looking at the bigger picture of housing unaffordability
But there is little momentum to support the price surge in the last few years. Coupled with the fact that prime housing markets in the country are either saturated (like Penang and Kuala Lumpur) or nearly saturated (like Negeri Sembilan, Johor and Selangor) in terms of supply, the country’s housing market has started displaying an inflection point in its growth. As the high-growth stage that came with the speculation herd instinct and widespread investment becomes less prevalent, houses in the market for the next few years are unlikely to be overpriced. Instead, the main culprit of worsening housing affordability is the decreasing household income and purchasing power caused by a subdued economy.
With rising material costs, any increase in the cost of doing business will definitely bring a fundamental price increase to the product. However, such a hard cost increment is considered healthy and should not be treated the same as house prices surge that causes overpricing. In this sense, one should not be too pessimistic about the property market in 2022. Though there could be a price increase, if the market sentiment is flat, then the demand will also be affected. There is a ceiling for property developers to increase housing prices. Also, the country’s housing market is still marred by issues such as overhang, affordability, high household debts and tighter credit standards. This gives little room for price hikes.
Moreover, judging by the subdued outlook of the construction sector, it is still uncertain to what extent rising material costs would impact price increment. Based on the Royal Institution of Chartered Surveyors (RICS) Global Construction Activity Index (CAI), which is a measure of current and expected construction market conditions among construction professionals, Malaysian construction activities remained stuck in negative territory in Q3 2021 (-38), improving only slightly from Q2 2021 (-44). It has yet to return to pre-pandemic levels (Figure 4).
How concerned should we be over soaring steel prices?
A further review of the value of construction work done in the country supports the idea that a full rebound of the construction industry seems unlikely. The value in Q3 2021 (RM24.8 billion) was still lower than the preceding year (RM31.4 billion) and even much lower compared to Q3 2019 (RM36.1 billion). Obviously, if local demand does not pick up, any cost increment in building materials is hard to sustain.
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This can be observed in steel bar price movements. As shown in Figure 6, prices recovered twice since 2019, at Q1 2019 and Q2 2020, due to an influx of supply and keen rivalry among domestic steel players respectively. Even as the first Movement Control Order (MCO 1.0) was announced towards the end of Q1 2020, the second recovery had bolstered steel prices against a deep plunge. Steel bar prices only experienced a slight dip and regained stability a mere 1.5 months after MCO 1.0. Pandemic-induced supply chain conundrums such as restricted production, tighter standard operating procedures (SOPs), production labour shortages, reduced raw materials and limited vessels continued to fuel price increase until Q1 2021. By MCO 3.0, steel prices had soared to RM3,310/RM3,460 per mt – the highest they had ever been in three years since 2018. Nevertheless, steel prices experienced downward pressure since Q3 2021.
In Figure 5, a Y-O-Y plunge in the value of construction work can be seen beginning from Q1 2019 (RM37.4 billion) to RM35 billion and finally, RM31.3 billion in Q1 2021. With no additional supply during the period coupled with slow construction activity, it is apparent that the domestic steel bar demand is plummeting. In fact, it is the post-pandemic “controlled supply” market, in one way or another, that has suppressed a harsher fall. As such, the trend of soaring steel bar prices is highly unlikely to continue. It will normalise unless and until demand or supply is disrupted once again.
On this basis, there should be no house price boom in 2022. Should there be one due to rising material costs, it is considered a fundamental pricing increase, which is unlikely to be backed by speculation that could result in overpricing and a risk of a housing bubble.
This article was co-authored by Dr Foo Chee Hung, Principal Researcher at MKH Berhad and Brandon Loo, General Manager at MKH Building Material Sdn Bhd.