THE INTEREST RATE QUANDARY

Private Property South Africa
Justin Clarke

The trick to investing in property is efficient gearing, put simply, using a large proportion of other people’s money, most likely borrowed from a bank. If you have a large proportion of your real estate portfolio financed, and the total value of the Real Estate goes up by a few percentage points, your return on the capital employed is significantly higher than if your portfolio was entirely funded with your own cash.

I stuck my head out recently when I wrote that inflation can be the property investors friend, and this of course is especially relevant when you are geared. The effect of a period of high inflation is that the capital amount owed to the bank becomes worth LESS in real terms than when you borrowed it. Also the rentals paid by your tenants will become cheaper relatively , providing room for you to escalate them. The replacement cost will also appreciate with inflation.

The downside to inflation is that interest rates in South Africa are used as a first tool by the Reserve Bank to counter it, so rates are hiked to keep inflation within the government prescribed ratio, and that means we end up with a variable monthly cost which is very dangerous if you have not provided for it.

We can be pretty sure now that interest rates are on their way up. The banks have already made the assumption that rates will be increased by the end of the year by 0.5%, although SARB is still talking about early 2012.

Is there any way to negotiate a fixed rate from the bank?

My view is that I will not fix at this stage. Firstly I don’t believe rates will run like they did in the last cycle, because we are still over extended (our debt ratio is too high) and an increase of more than 2% will be extremely uncomfortable for homeowners. (John Loos – FNB Property Market Analytics 25 March 2011)

Secondly, we are already experiencing “cooling” measures that are not interest rate related as we pay more for fuel, electricity, water, rates, and road tolls.

But the most important reason why I wont fix is that the bank gets to employ a very clever bunch of analysts and actuaries, who calculate these risks for the bank. The purpose of offering fixed rates is not for your well-being but for the bank to make money out of you. So if the bank thinks they will be safe with a 3 % premium then I am NOT going to bet against them.

There is always a case for fixing your home loan rate, and we have not considered wildcard external forces like escalation of unrest in the Middle east and Nuclear catastrophe in Japan, both of which are possible.

If you want to be safe then remember that the option is available and it’s probably a good time to consider it now.

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