Effects of impending rate hikes on the property market.
Impending Interest Rate Hikes, how will this affect the Property Market.
For many of us the last round of interest rate hikes combined with the 2007/8 recession and the effect it had on our financial situation is still very fresh in our memories, it was a very painful time. Servicing our existing Bonds increased by as much as 40-45%, property values dropped in many cases below cost and the banks tightened up on lending. Suffice to say the Property Market plummeted and there was nothing you or I could do about it, it was beyond our control. Many of us are probably just starting to recover from the effects of this period only to have the Reserve Bank send shivers down our spine by announcing that interest rates will start to increase again soon.
Prime Interest Rates since 1948 to present.
Why do Interest Rates Fluctuate?
South Africa is a very small economy on the world stage. The Reserve Bank utilise’s interest rates not only to control domestic influences on inflation, but also to protect our economy from international variations. The South African Reserve Bank has set itself the target of maintaining inflation at between 3-6%.
The inflation rate has been hovering just below the 6% point for some time now enabling the Reserve Bank to keep interest rates fairly steady at the lowest levels for around 30 years, but this picture is changing. Normally inflation is driven by the balance of supply and demand, if something is in short supply, or if something is in great demand we see prices rising to curb demand or to enable an increase in production. South Africa with it’s sluggish economic growth and increasing unemployment is NOT seeing demand driven inflation, but cost driven. The drop in oil prices is reversing and oil prices have increased back to just below $65 a barrel, the Rand has also weakened somewhat in recent weeks meaning that we will see an increase in fuel prices. Eskom is pushing for a 25% increase in electricity costs to cover their exorbitant diesel bill as they need to run old inefficient generators to keep the lights on and require Billions of Rands to upgrade their current capacity. Unions in the public and mining sector have been pushing for and achieving above inflation increases. All these rising costs in basic production factors will result in inflation increasing above the 6% ceiling leaving the SARB with little option but to initiate an upward trend in interest rates.
What effect will Interest Rates have on Property.
Interest Rates have always had an effect on the property market, but periods of uncertainty or changing rates seem to have a greater effect. The property market is ultimately driven by people and most people are driven by a range of emotions from utter euphoria to complete despondency. We definitely saw the full gambit of emotions on display through the euphoric period of 2005/6 followed by the fear and panic of 2007/8 as the property market crashed and we went into recession.
At no point do we believe that the upcoming rate increase period will result in the same panic we saw in the last recession, but it will still result in a degree of uncertainty which may temporarily dampen the property market.
What we witnessed in 2007/8 was the perfect storm of multiple factors all coming together at the same time to devastate the property market, excess supply, worldwide recession, dramatically increasing interest rates and falling property values. Despite this the South African property market was hit somewhat less severely than some other western markets.
Naturally when interest rates start to increase the affordability of property is negatively affected resulting in potential buyers becoming a little nervous and either withdrawing from the market or altering their affordability expectations accordingly and opting for something smaller, potential sellers may decide to rather stay where they are and make do with what they have as opposed to upgrading. The above graph shows how monthly payments increase per percentage increase in interest rates on a R1 million bond, each one percent increase results in an effective 7% decrease in affordability to new buyers, as interest rates are currently at a 30 year low new buyers may have to factor a few percentage point increases into their budget.