‘Silver linings’ in investment headwinds
Property investors face inflationary and interest rate challenges unseen for many years but economists also think there could be silver linings.
The Reserve Bank is forecasting the official cash rate (OCR) to peak above 3.25 per cent by 2024 but markets are pricing in around 4 per cent, prompting many banks to raise home loan floating mortgage rates to more than 5 per cent.
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.
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.
CBD 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.
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.
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 per cent but this has reduced to as little as 33 per cent in some cases.