Is dropping the repo rate by 50 basis points the best thing for property owners?

Who wants to have their cake and eat it too?
It is a strange idiom to have your cake and not want to eat it. We all want to eat the little piece of cake we work so hard for. So, the Reserve Bank dropped the repo rate by 50 basis points last week in a surprise move as shown by the short upward blip in the exchange rate and the JSE. Homeowners are overjoyed at this reduction (and the preceding 5) but is this really the best thing for property owners?

The repo rate
The repo rate is the Government's attempt at regulating inflation. The Reserve Bank dictates the interest at which they 'lend' money to banks that then adjust their rates to customers in accordance with this. In the current environment Tito Mboweni and the Monetary Policy Committee (MPC) decided that the projected inflation outlook was benign enough and squarely with the targeted 3-6% range to drop the rate by ½% last week.

Inflation
Now inflation is a funny thing. Inflation is seen as a necessary evil by some and a downright pain in the rear by most, but it might be a property owner's best friend. Although interest rates and inflation are inextricably linked, today I want to tackle inflation separately to the knock-on effects that interest rates can have on property prices even if interest rates have been given the credit for part of the dramatic increase in property prices over the last 2 years. (A ½% reduction in the interest rate some say translates into a 10% increase in house prices. This could partially explain a 50% increase in property prices over the last two years. I know this argument is flawed, as an increase in rates doesn't necessarily translate into a downward adjustment of property prices.)

Low vs High Inflation
Now, back to inflation. For the purposes of the following example, assume that property prices track inflation (Let's not get into this ball of wool just yet). Once property prices have adjusted to interest rate changes, the question remains, is a low inflation environment good for property owners? Initially bondholders are happy for any reduction in their repayments (which is a cashflow issue), but if this lower inflation results in a slower increase in the escalation of property prices, it's a negative. Let's use an example: You purchase a home or R1 million, just to keep numbers simple. Assuming an inflation rate and equivalent price increase in property of 5 % over the next 10 years, this property will be worth R1.5 million in tens years time. If inflation tracks at 10% the same property would be worth R2.35 million in ten years time. A 55% growth compared to a 135% growth. There is a substantial difference to the bondholder's monthly repayments, however. This is somewhere in the order of 30%. But again, the higher inflation erodes the real repayment value to the bondholder in the 10% scenario quicker even if it does initially cost more.

The ideal situation would be for a relatively low, stable inflation rate coupled with a moderate growth in property. More discussion here would entail examining the link between inflation and property prices in much more detail.

Where's my cake?
Given all of the above, property owners should be asking themselves, 'why can't I have my cake and eat it too? Why can't I have a low inflationary environment with a moderate to high property price growth?' Between Trevor Manuel and Tito Mboweni, the next few years might be just that. The adjustment to the lower inflation figures should still be filtering through and optimism fuelled by a stable lower inflation should both contribute to higher than inflation growth in property prices.

Conclusion
South Africa might well be in the fortunate position of enjoying a lower inflation rate while property owners reap the benefits of a robust property price growth. The irony here is that while South Africans live in the fear that someone is about to snatch their proverbial cake away at any minute, the effects of this confidence will still remain muted. It is this very fear that prevents people from confidently investing in a long-term vehicle like property.

Article by : Dave Welmans - (www.thepropertygame.co.za)