SARB hikes rates for the 3rd time in the cycle. While rate hiking is usually a “dampening” force on property, the Commercial Property Market’s strengthening in sales activity may have some “legs” before peaking later this year, despite the March rate hike.
“The Residential Rental Market could receive some mild support.
“Last week, the SARB (South African Reserve Bank) Monetary Policy Committee (MPC) made the decision to raise its policy repo rate a further 25 basis points, following on its first 2 hikes of 25 basis points in the current cycle at its November 2021 and January 2022 meetings,” says John Loos, Property Sector Strategist at FNB Commercial Property Finance.
“The cumulative rise in the cycle to date is thus 75 basis points, and this will bring average Prime Lending Rate of the main commercial banks to 7.75%.
“The rising short term interest rate cycle does contribute additional upward pressure to long bond yields, although these got their main upward lift in February/March from the onset of the Ukraine conflict, the resultant concern in increased inflationary pressure, which in turn raises the possibility of higher interest rates in future in general, rather than from the latest SARB interest rate hike.”
Loos adds that consumer price inflation became more troublesome over the course of 2021 as the global and domestic economies recovered, with CPI (Consumer Price Index) inflation accelerating from a lowly 2.9% year-on-year in February 2021 to 5.7% by February 2022.
“This puts the inflation rate at very near the upper limit of the SARB’s 3-6% CPI Inflation target range, requiring some policy action. In addition, the recent Russian invasion of Ukraine, the ongoing conflict, and the resultant boycotts and sanctions of Russia, have ‘upside risks’ for inflation emanating from various potential supply shocks. Potential food price and oil price inflation shocks are a key concern.
“Inflation had become a prominent global issue well-before the Ukraine invasion, however, fueled by the combination of massive fiscal and monetary stimulus to cushion the lockdown blow in 2020, and major supply chain disruptions in many parts of the world due in large part to Covid-19 related disruptions.
“This implies interest rate hiking in many parts of the world economy, the US Federal Reserve being the key central bank recently commencing with its rate hiking.”
Loos says that FNB expects gradual rate hiking to continue this year and into 2023, with a further 4 x 25 basis points’ worth of rate hikes forecast for this year alone.
The main expected implications for the property market are as follows:
- Rising short term rates add additional upward pressure to Government long bond yields, as mentioned, along with ongoing high rates of government borrowing and a rising global interest rate cycle also pressuring long bond yields. Rising long bond yields are in turn expected to exert upward pressure on certain key property capitalization (Cap) rates. We would expect the multi-year rising trend in Office and Retail Property Markets’ cap rates to continue in 2022 as a result, sustaining pressure on real (inflation-adjusted) property values. However, the Industrial Property Market may just “escape” in the near term, with that sector’s declining vacancy rates of late pointing to relatively strong income growth prospects, leading this sector to possibly continue to buck the rising cap rate trend.
- Rising capitalization rates in Office and Retail Property are expected to sustain pressure on valuations, and this could see the Office Market, with its very high vacancy rate and declining rentals, remaining in declining valuations territory in the near term.
- The rising interest rate cycle is expected to lead to the pace of new residential development peaking during 2022, and we expect to see new residential plans passed slowing down later in the year.
- The rate hiking cycle is expected to provide some mild support for the Residential Rental Market. Typically, rising interest rates can see a portion of aspirant home buyers delaying their purchase, taking a “wait and see” approach to the interest rate hiking cycle. This can see the home buyer exodus from the rental market slowing, which in turn can lead to lower vacancy rates and higher rental inflation. In the latter half of 2021 we had already seen early signs of a turn in vacancy rates lower and a small recovery in rental inflation, so rate hiking could support a continuation of this mild recovery.
“However, the rental tenant population is financially fragile, so interest rate hiking cannot go too far before increased financial pressure begins to hurt tenant performance and dampen the rental market. But in the near term we would still expect some mild strengthening,” Loos adds.
“Finally, after some mild resurgence into positive year-on-year growth territory in the 2nd half of 2021, later this year could see growth in new commercial property mortgage lending tapering as the commercial property market starts to cool.
“Industrial property demand could conceivably continue to grow, buoyed by the area of logistics and a sector gearing up for greater levels of online retail. However, the weaker Office and Retail Property Sectors could see cooling in sales activity in the latter half of 2022, because of further rate hiking.”
He adds that in the very near term, we don’t expect the Commercial Property Market’s rising trend in sales activity, as per the FNB Property Broker Survey, to stall just yet.
“This may possibly happen later in 2022 on the back of further rate hiking. But for now, market activity appears to be benefiting from the lagged impact of improved economic growth through 2021 following the huge 2020 contraction.”