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Rode Report warns against impending interest rate hikes

MAIN IMAGE: Erwin Rode, property economist

Danie Keet

The prospect of rising local interest rates from 2022/23 onwards does not bode well for house prices over the medium term.

“We believe the upcycle in global interest rates has already begun”, says Erwin Rode, property economist, in the latest Rode Report on the SA Property Market.

Rode cited both South Korea and Brazil, where rates have already been hiked, fuelled by faster increases in inflation in the wake of accommodative monetary policies, supply-chain disruptions and the resultant shortages of several products. He also believes the Fed in the USA would start to lift rates by late 2022 or early 2023.

“This means the start of an upward interest rate cycle in South Africa cannot be far away. We’d best brace ourselves for the future.”

Despite these looming circumstances, the report also reflects that the property market continued to recover in the third quarter of 2021.

“This can be seen specifically in a further increase in listed property prices which, at the end of this quarter, were 20% higher than at the end of 2020,” notes Rode.

But looking at the bigger picture, prices were still 10% below those at the end of February 2020, just before the pandemic initially raised its head: “And we have no idea yet what effect an expected fourth wave at the end of 2021 may have, particularly with the slow vaccine roll-out we are experiencing.”

Because of this, believes Rode, the office market will need to continue to brace itself for tougher times over the short term as many office workers continue to stay away from the office. However, he also believes the work-from-home (WFH) trend over the long term is probably overstated.

“This simply doesn’t work for many companies, particularly large corporates, as humans need face-to-face interaction to build both company culture and morale. More than likely, what we will see is the rise of a hybrid model where workers split their time between office and WFH.”

Nevertheless, the vacancy rate reported during the quarter within the office market was the highest this century has witnessed, at an average of 14% across the country. The worst grade-A rental declines were reported in Cape Town decentralised (11%) and Johannesburg (6%). With rentals having also declined by 5% in Pretoria, this showed that no major city had managed to record above-inflation rental growth.

Industrial property, however, currently finds itself in the strongest position compared to other non-residential property types, and even retail is beginning to recover.

“The industrial sector is now comfortably the best-performing non-residential sector, largely due to the non-speculative nature of developments,” says Rode.

While rental growth was still well below the 5% of 2019, the third quarter at least showed a 2,6% year-on-year growth, accompanied by low vacancies. A real surprise was Cape Town, where nominal rental rates had rebounded with a growth of 3,7% compared to the third quarter of 2020 and after falling for four consecutive quarters.

Returning briefly to the residential market, while the pandemic spurred a renewed interest in homeownership when interest rates dropped, a cooling down period has begun. From a mid-pandemic peak of 5,1% year-on-year growth in April 2021, national nominal house price growth stood at 3,5% year on year over the last quarter.

“This is no surprise,” notes Rode. “There has been record-high unemployment recorded. Add to this the impact of third-wave restrictions and the severe riots in July and we can understand why this market is now experiencing a setback.”

Flat vacancy rates in South Africa declined to 10,2% in the third quarter after hitting a peak of 13,1% in the fourth quarter of 2020, but remained high compared to historical levels, leaving rentals under enormous pressure.

“A cautionary tightening of our belts must remain the order of the day for the foreseeable and still unknown future,” concludes Rode. “These are strange days and while economic forecasts can be turbulent at the best of times, we now find ourselves in highly uncharted waters.”

Some of the influences of higher interest rates on the property sector:

  • Interest rates can drive property prices in a variety of ways.
  • Like the discounted cash flow analysis conducted on equity and bond investments, the income approach takes the net cash flow into account.
  • Interest rates can affect the cost of financing and mortgage rates—changes in capital flows can also have a direct impact on the supply and demand dynamics for a property.
  • The most evident impact of interest rates on real estate values is in the derivation of discount or capitalization rates, as they are equal to the risk-free rate plus a risk premium.

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