Economists from Firstrand expect the interest rate to increase by 25 basis points this week. Find out the implications for the property market if this happens.
The reasons the bank expects interest rates to increase
The South African Reserve Banks’s target range for CPI (Consumer Price Index) is between 3% and 6%, and while inflation in September was 4.9%, there is a belief that the SARB focuses on the “mid-point” of this range or 4.5% instead.
Firstrand economists also expect inflation to rise in coming quarters due to the effects of recent rand weakness, VAT increases and fuel price hikes. In Gauteng, fuel prices rose a staggering 22.3% year on year in November.
Economists are split on whether the rate hike will come this week or early next year, due to the slightly better performance of the rand recently and decrease in oil prices.
Regardless of whether the interest rate is left unchanged or increased, the bank expects the “softening” of the property market to continue due to ongoing economic weakness.
John Loos, Property Sector Strategist for FNB, explains how interest rate hikes could affect the residential and commercial property markets below.
The potential impact on the Residential Property Market
According to FNB Estate Agent Survey, the average time of homes on the market was 17 weeks and 6 days in the 3rd quarter of 2018. This is up from 14 weeks and 1 day in the 1st quarter survey, and from 11 weeks and 1 day at the start of 2016.
It currently takes 17 weeks and 6 days on average to sell a home in South Africa
Even the interest rate cut of March did not change this broad trend, the 2nd quarter 2018 survey straight after that rate cut showing a lengthening in the time on the market from the “pre-cut” 1st quarter survey. The start of an increasing trend in time on the market, at the start of early-2016, coincided with nominal house price growth slowing to levels low enough for real year-on-year house price decline to commence from early that year too (“real” referring to house prices adjusted for CPI inflation rates).
This trend of real house price decline since early-2018 has not been halted despite 2 x 25 basis point interest rate cuts, one early in 2017 and one early in 2018.
At current house price growth rates, a 25 basis point rate hike probably wouldn’t stop the trend towards greater home affordability either. In October, the year-on-year growth in value of a 100% new loan on the average priced home rose by a mere 1.5%. We calculate that a 25 basis point rate hike would take this growth rate up to 3.3% year-on-year, a rate which still remains below the CPI inflation rate as well as below nominal per capita income growth.
Therefore, it would take more significant rate hiking at this stage to cause the resumption of a deterioration in home affordability, given currently weak nominal house price growth. And with supply relative to demand looking set to remain strong in the existing home market, the recent “flurry” of growth in residential units built (26.8% year-on-year for the 3 months to September 2018 according to StatsSA building stats), looks set to be short lived, the New Development Sector to be challenged by improving affordability in the existing home market.
Potential implications for the Commercial Property Market
Both a rate hike or rates unchanged scenario is expected to sustain an environment that exerts upward pressure on capitalization (Cap) rates, resulting in property values coming under pressure in real terms. The economy remains very weak, pushing certain vacancy rates higher, and with Government revenue growth under pressure we have continued to see the government debt-to-GDP ratio rising, which has exerted upward pressure on long bond yields in recent years.
In the Commercial Property Market, even 2 rate cuts in 2017/2018 have not managed to alter the broad gradual softening direction up until the 1st half of 2018.
IPD half-yearly data for the 1st half of 2018 was released in October, and this showed a further decline in total half yearly returns on commercial property, from 5.5% in the final half of 2017 to 4.7% in the 1st half of 2018, continuing a broad decline that started back around 2013/14. Half-yearly returns have gradually tapered from a post-Financial Crisis high of 9.5% reached in the 1st half of 2013.
Capital growth slowed from 1.6% half on half in the final quarter of 2017 to 0.7% in the 1st half of 2018, meaning that in real terms (adjusting for GDP inflation) we saw the 3rd consecutive half of decline.
What is holding the property market back?
Interest rates are low by South Africa standards, so cannot be seen as a major dampening factor. Sentiment plays a key role, and currently, weak sentiment arguably stems more from economic policy uncertainty in addressing the structural problems holding economic growth back.
At economic growth below 1%, demand for commercial property appears insufficient to prevent vacancy rates from rising, and such a rise in the All Property Vacancy Rate has taken place through 2017 and the 1st half of 2018 according to IPD (MSCI) data. Higher vacancy rates ultimately should curb rental income growth, and this should impact on capital growth.
In short, interest rate cutting appears the least likely scenario this week, with the debate between unchanged rates and a 25 basis point hike, Firstrand expecting the latter. In the near 1% per annum economic growth environment of recent years, with South Africa’s myriad of structural constraints taking their toll on economic growth, the property market has been unable hold its average value in real terms. The gradual real value decline started around early-2016 in the case of residential and a similar time in the case of commercial. 2 small rate cuts in 2017/18 have not arrested real value decline, so we would expect that either an unchanged or rate hike decision would keep the gradual declining trend in real values intact.