Property investors face new inflationary and interest rate challenges unseen for many years, but economists also think there could be silver linings.
The Reserve Bank of New Zealand (RBNZ) is forecasting the official cash rate (OCR) to peak above 3.25% by 2024, but markets are pricing in around 4% prompting many banks to raise home loan floating mortgage rates to more than five percent.
On the other side of the equation, savers can expect increased, though still negative, real (inflation-adjusted) returns.
Economist Cameron Bagrie of Bagrie Economics says some of the downside risk to asset values from rising interests can be partly offset by inflation which tends to be good for physical assets as their replacement cost increases. He also notes that we could see some boutique trends such as some manufacturing coming come back to New Zealand, benefitting industrial property as we move into a less globalised and outsourcing era.
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Bagrie says commercial property and land assets have traditionally offered some protection against inflation.
The replacement cost of a building is skyrocketing, and therefore current investors have a partial hedge against rising interest rates in place, Bagrie says.
The COVID-related environment has also benefitted some industrial properties with more companies engaged in online shipping warehousing, in line with longer-term trends, he says.
Central business district retailing is weathering a storm, but suburban retailing is performing better, partly due to people working from home, Bagrie says.
He doesn’t think New Zealand will return “to the bad old days” of double-digit inflation but it may be around for a while, with labour in short supply, bigger pay rises, rising benefit dependency, COVID-19 logistical challenges, and the Russia-Ukraine conflict all having an impact. Central banks are facing an inflation challenge and that means higher interest rates.
Bagrie says, faced with a rising interest-rate headwind, the earnings stream for the asset is critical. Investors and tenants are being more selective, and landlords will look at what more they can do to get the best out of their assets.
Bayleys’ head of insights, data and consulting, Chris Farhi says despite challenges, rental growth is benefitting some commercial landlords.
Higher interest rates will generally translate to higher yields, but the weight of investment money will help insulate some assets, particularly industrial properties and large format retail properties with essential service tenants.
“The returns on term deposits remain poor with negative real returns after you account for inflation. Real estate provides the opportunity for income growth (rents) and capital growth,” Farhi says.
Kevin Miles, property finance and commercial adviser with Vega Lend says he doesn’t think inflation will stay around as long as many people think.
Part of the current supply chain problem that feeds inflation is that many businesses are stockpiling materials.
He says, instead of sitting on Bunnings’ shelves, materials are being stockpiled in warehouses to ensure builders have supplies to complete future projects. At some stage confidence of supply will return and the stock will be released.
It’s also getting increasingly expensive to tie capital up in materials that aren’t being immediately used, especially when bank lines are already heavily used to provide bonding requirements given the recent strength of the development market.
Miles says in the meantime, funding of commercial and industrial investment is facing new constraints.
Increasing interest rates have resulted in interest cover ratios becoming the main constriction on the amount advanced by banks. As a result, banks require significantly higher equity deposits from investors trying to leverage investments – in the past, they could typically borrow up to 65 percent, but this has reduced to as little as 33 percent in some cases.
Eventually, the situation will self-correct as high equity requirements drive buyers out of the market, eventually resulting in falling or steady prices, he says.
“As prices fall and yields rise, investors will be able to get more leverage again,” Miles says.
However, for residential property owners, there is a silver lining. Whilst inflation drives asset values up, correspondingly in real terms it reduces the relative burden of repayment of debt. At current inflation rates in relative terms, a typical mortgage is being reduced more by the inflation effect than by the principal payments being made by the borrower.
Miles says we may see an environment of improved housing affordability and a reduction in the burden of debt service for highly leveraged borrowers that can survive the short-term financial implications.
- Article supplied by Bayleys
