The Story of Housing and the Economy: Decoding the Housing Construction and Housing Rental Value Chains

The housing sector influences national economies in three important ways.  Firstly, while housing fulfils a basic human need for shelter, it also provides the base from which households participate in the economy. Secondly, housing is the largest asset most households will accumulate over their lives and therefore comprises an important part of most countries’ generation of wealth. And thirdly, the construction, trading and rental of housing stimulates the production and sale of goods and services, impacting on many parts of national economies.

While most people agree on this, what is less understood is the degree of impact, or where in the developing economy it creates impact.   While figures are often quoted for developed economies, these numbers and possibly also the analytical approach, don’t fit too well with our understandings of the nascent formal housing sectors, the high proportions of informal housing and the thin formal housing finance systems in the African context. The highly complex economic models explaining the impact and interrelationships between housing sectors and economic growth and cycles are poorly suited for application in the new markets that characterize African housing sectors, especially given that the available data is so thin.

The first blog in this series discussed the “housing production value chain”: that process through which raw land is identified, planned, surveyed and registered, serviced and sold, and on which accommodation of whatever type is constructed, some financed with mortgage or unsecured finance, some built incrementally.  But this doesn’t assist us to adequately understand how housing impacts economies.  To do that, we need to unpack the housing economic value chain.

The housing economic value chain describes the economic linkages and impacts related to the construction and rental of housing. It sets out what raw materials, manufactured goods and services (intermediate inputs) are required, and where they are sourced in the economy.  It describes the extent to which developers, contractors and households add value to the economy during the process of building or renting houses (gross value added) through the addition of their intellectual property, management and skills (labour), rentals and profits, overheads and plant (gross operating surplus), as well as through the payment of levies and taxes (net indirect taxes). The value chain then calculates the economic value of the housing stock produced (domestic production) and the impact of this production being added to the country’s overall supply (domestic supply). Finally, how the total domestic supply relates to demand is shown.  Which economic sectors demand this supply as inputs to their own value chains (Intermediate demand), or whether it is used directly by consumers such as government, households or whether it adds to the formation of capital in that economy (final demand).

In summary, Intermediate Inputs (materials and services from upstream in the economy) + Gross Value Added (by the developers, contractors and households through value added inputs of labour, gross operating surplus and net indirect taxes) = Domestic Production (creation of new value in rentable or sellable housing stock). This is added to Domestic Supply, which is matched to intermediate demand (inputs to other value chains) or final demand for housing (from government, households or through additions to gross fixed capital formation in the economy). This basic economic process is illustrated in the Generic Housing Economic Value Chain below.

Having defined this economic process, the housing value chain can then be used to calculate the direct economic impact from housing production, sale, and rental.  This includes the initial impact of the value created in the process of construction or rental, and the first-round impact from the orders placed with the upstream suppliers of the intermediate inputs (raw materials, manufactured products and services required).  Then, the value chain calculates the indirect impact of the creation or rental of this accommodation on the economy – how the purchases from upstream suppliers impact the economy further in those suppliers’ value chains, a process that can pulse deep through an economy.  Finally, the value chain can assist to estimate how the salaries, interest, rents and profits earned in the housing value chain stimulates spending in the broader economy (induced impact).

So, the best place to start to understand the Housing Economic Value Chain is at the point where house construction happens.  A developer, contractor or household decides to produce a house, to meet a specific housing demand in the economy.  The house is specified, designed and costed, and finance is raised for the development.  Land is identified and secured, and infrastructure is installed. Then intermediate inputs such as building materials and manufactured components are ordered and brought to site. At this point, value added inputs (including management, capital, skills and labour, plant and machinery) in the construction sector are combined with these intermediate inputs to construct houses.  This process results in new economic value being created in the economy through the construction sector (Gross Value Added).

The central statistical services of most countries collect this data as part of the national accounts process, albeit at variable levels of detail and accuracy.  The data is often defined in terms of “Standard Industrial Classifications” (SIC).  To our knowledge, quantifying the housing sector specifically, however, is not often a core part of this process in developing countries, although many developed countries do closely monitor the housing sector.  To do this for a developing country like South Africa needs a refinement of data (where this exists) for broader SIC sectors (SIC5: Construction and SIC8: Finance, Insurance, Real Estate and Business Services) to calculate the specific contributions of residential construction and residential real estate. Note that we use the South African SIC breakdown here. However, this closely matches international definitions in the United Nations International Standard Industrial Classification (ISIC).

This value adding processes in the residential construction sector has important impacts up-stream in the economy.  The intermediate inputs needed for building housing are sourced and ordered from suppliers from many different sectors of the economy. Raw materials (e.g. timber, sand, stone, lime) are sourced from the primary economic sectors: Agriculture, Forestry, and Fishing (SIC1) and Mining and Quarrying (SIC2).  Manufactured goods and components are sourced from the secondary economic sectors and make up the bulk of these intermediate inputs. Wood and Wood Products (SIC321-322) include timber, roof trusses, door and window frames, doors and cupboards; Petroleum, Chemicals, Rubber and Plastics (SIC331-338) in the form of refined petroleum products and fibers such as paints, solvents, insulation materials and plastics; Non-Metallic Mineral products (SIC341-342), which importantly include cement and manufactured cement products including cement blocks, window sills and reinforced lintels, clay bricks and ceiling boards; Metals, Machinery and Equipment (SIC351-359), including basic and manufactured iron and steel products such as roof sheeting, reinforcing bar, frames, nails, screws and hinges, as well as plant and machinery; and Electrical Machinery and Apparatus (SIC361-366) such as electrical wiring, distribution boards, geysers, switches, globes and transformers.

The housing value chain also draws on intermediate inputs from tertiary economic sectors. These include Finance, Insurance, Real Estate and Business Services (SIC8) such as financial services, estate agency, property management, legal and marketing services; Community, Social and Personal Services (SIC9) and to a lesser extent Trade, Catering and Accommodation Services (SIC6) and Transport, Storage and Communication (SIC7).

Intermediate economic inputs are combined with value added inputs to create gross value added during the construction or rental process. In the process of constructing housing, the Construction Sector (SIC5) adds significant value to these intermediate inputs. Both the Building Construction sector (SIC51) and to a lesser extent the Civil Engineering and Other sector (SIC52-53) contribute to the gross value added during construction. This value added during the construction process takes three forms:

  • First, through value added by labour. This is a catch-all term for all managerial, supervisory, professional, skilled and semi-skilled inputs employed on a permanent, contract or informal basis in the construction industry, that contribute to the housing development, construction process.
  • Second, value is added that is measured as Gross Operating Surplus. This is the sum of all rentals, interest and profits generated during housing construction.
  • Third, during the development, construction process, taxes and levies are paid, hence creating added value for application through the governmental sector.

The gross value added to the intermediate inputs produces domestic housing stock that is added to a country’s domestic housing supply.  In a well-functioning housing market, where there is enough housing to meet the different needs of the population, this total supply should closely match the unique demand profile, in terms of housing type, affordability sub-markets and tenure preferences (ownership or rental).

The housing construction value chain is the producer of new housing stock, but another significant housing value chain contributor exists in the housing rental value chain. In the housing rental value chain, housing stock is procured and applied to rental demand. The housing rental sector draws much more on services (tertiary sector), with limited manufacturing (secondary sector) inputs. While during housing construction, value is added once during construction and thereafter only when a house is improved incrementally over time or replaced, in the rental value chain each unit adds value every year it is rented.  Therefore, even in an economy where more households own than rent, the rental value chain can add significantly more monetized value to the economy because it does so repeatedly.  Of course, home owners also get value out of their houses each year, and in many countries, notional amounts are included in national accounts to provide for this.  But the rental sector is a more overt economic contributor, due to the economic transfers (rent) that it stimulates.

The housing value chain is just as effective in tracing the impacts of the development of a luxury, multi-level mortgage financed penthouse as it does the impact of an incremental process of a single household constructing their own informal home.  All housing construction and rental activity adds economic value through the same value chain, albeit to different extents in different parts of the economy. While the housing construction value chain creates the most value in Construction, (SIC5); Manufacturing (SIC3); Finance, Insurance, Real Estate & Business Services (SIC8); and Trade, Catering & Accommodation Services (SIC6), our analysis indicates that the housing construction and rental value chains register important impacts in every major industry sector (SIC 1 to SIC9). Critically, the construction and rental value chains have very different intermediate inputs and contribute very differently to gross value added.  These two components of the housing value chain therefore work in tandem to stimulate and grow many economic sectors across an economy.

This is not the end of the impact that residential construction and rental have on the economy. There are further economic pulses (indirect and induced economic impacts) that are generated by the housing value chain, because activities in any economy are closely linked. The suppliers of intermediate inputs to the housing construction and rental value chains have their own unique value chains to create their products. For example, a geyser manufacturer sources metals, plastics, insulation and pre-manufactured plumbing and electrical components, adds value to these to create a product that meets down-stream demand.  The housing value chain therefore creates an economic pulse upstream in the economy – in the case of the geyser, in the mining, smelting, metals manufacturing, plastics, electrical and plumbing components sub-sectors of the economy, and in turn in each of those sub-value chains.  In this process, indirect economic impacts are generated from the direct housing value chain deeper and wider into the economy.

Of course, the economic impact of housing is also felt ‘down-stream’. Housing helps to stimulate demand for furniture, appliances, garden equipment, security and other home-related services.  However, we will discuss these indirect and induced impacts in more detail at a later stage.

From our analysis of the impact of housing in the economy, we know that beyond producing housing, the housing construction and rental sectors are important creators and stimulators of economies, and help to directly stimulate local primary, secondary and tertiary economic sectors. Further, the housing value chain is an important employment creator and sustainer, if it is sustained and grown over time. Growing and maintaining a consistent level of housing construction and rental activity in any country should therefore be an economic priority beyond the need for shelter.  There is no doubt that sustained activity in the house construction and rental sectors plays an important role in balancing and growing developing economies.

In the next blog, Benchmarking Housing Construction Costs in Africa, we highlight the size and structure of the housing construction and rental value chains in South Africa. The third blog, The Story of Housing and the Economy: Exploring South Africa’s Housing Value Chains, is the methodology applied in an African country.

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