Is the right time of rising interest in property stocks a sign that the worst in the economy and the local property market is behind us? A number of research houses and property analysts are beginning to think so.
For one, looking into 2010, local research unit banker research institute believes that inflation or asset reflation could gradually emerge as a catalyst for the greater local stock market performance, given the existence of ample liquidity with prolonged low interest rates, prospects of a further weakening in the US dollar as well as rising commodity prices.
Under such circumstances, it points out that sectors that could benefit are oil and gas, plantation and property. According to the research unit, this is particularly true for the local property market, which it sees as being in the early stages of a recovery cycle and likely to gain further strength in 2010, given the ample liquidity, prolonged low interest rates, rising consumer confidence and a recovering economy. According to banker research, this is reflected in improving developers’ property sales since 2Q09, thanks to their aggressive marketing strategies (such as the 5-95 scheme) and improving property demand.
However, there is also the potential risk of countries implementing ‘exit strategies’ or policy tightening as soon as their economies show some recovery, which may lead to greater volatility in world financial markets in the year ahead as well as a potential rise in the underlying interest rate.
Already, Israel has raised interest rates and China has tightened its banks’ lending conditions to prevent the build-up of an asset bubble. Reserve banks of Australia have also raised their benchmark rate by 50 basis points (bps) and South Korea is also signalling the need to gradually raise rates as the global economic expansion gathers strength and a recovery is firmly established. While the domestic overnight policy rate (OPR) is likely to remain at the current low level of 2% at least until mid-2010, most economists expect a potential hike of 25-50 bps in 2H2010.
In this case, will the reversal in the trend of declining interest rates hurt property demand and stymie the current sector recovery? As it is, most property sector stocks have not recovered to their highs even as they have bounced off substantially from their lows since March this year and most investors are now in playing on the sector recovery theme. We look further at the sustainability of the current underlying property up-cycle if interest rates start rising ahead in this story.
Underlying Demand Seems Sustainable
According to various research houses, the current rising property demand is seen as sustainable, given a rise in consumer sentiment and the still high affordability of property ownership in the country, among others. For one, the sharp jump in consumer sentiment recently is likely to translate into strong demand for big-ticket items like property due to the high correlation between the two. The MIER (Malaysian Institute of Economic Research) Consumer Sentiment Index (CSI) has jumped significantly from 78.9 in 1Q2008 to 105.8 in 2Q2009. The CSI has now surpassed above the loo-benchmark for the first time since 2Q2008, and if this is sustained in 3Q2009, it will suggest that there is a trend of a strong recovery in consumer confidence (see Chart .1)
Another major push factor for the local property sector is undoubtedly the rising affordability that has successfully helped to boost property demand. Another local research house, Affin Investment Bank Research, reckons that the major difference in the current cycle now from the previous sector down-cycle is the all-time low interest rate.
As such, for this time round, the fall in property prices has been lower compared to the 1997/98 Asian Financial Crisis period where properties were heavily used as collateral for trading financing, which is not the case now. The current low interest rate and the resultant low mortgage rates have managed to stimulate property demand in Singapore and Malaysia despite overall weakness in the economy.
RHB Research agrees.
It reckons that the surge in the current house buyers’ affordability is supported by the low interest rate environment and attractive financing packages offered by banks. Bank Negara Malaysia (BNM) has kept its Overnight Policy Rate (OPR) unchanged at the historical low of 2%, making borrowing costs very attractive. This is further supported by attractive house financing packages offered by bankers (eg, the current mortgage rates are at around base lending rate (BLR) minus 2.0% to 2.5%).
Lower financing costs translate into higher purchasing power and hence, increasing demand for properties. Chart 2 clearly illustrates this. Back in 1980 when the average lending rate (ALR) of banks was recorded at 10.13%, the affordability index back then was pegged at the 100-mark level. In August 2009, the ALR only came up to 4.84%. Assuming a similar property price and financing tenure as well as income, the affordability of a property buyer will now be higher at around the 120-mark, meaning 20% higher as opposed to what it was then in 1980. Even in the event of rising interest rates, say by 5o bps, the affordability index is only likely to fall to 116.85, a mere 1.3% from the current level.
Apart from that, a continuous low interest rate regime will encourage investors to switch their investment from lower return assets, such as fixed deposits, to better return inflation-hedged assets such as properties.
In Malaysia, attractive housing packages offered by developers like deferred payment schemes (ie, 5-95 home loan package where house buyers will only have to make a down-payment of 5% and repayment of mortgage will only commence upon completion of the property) are also powerful incentives that improve house buyers’ affordability. Under the ‘deferred payment’ scheme, house buyers need not worry about their cash commitment until two years later (after the completion of construction works). This will enable house purchasers to save on the interest payable during the construction period and enjoy possible capital appreciation upon completion.