Rising interest rates may not stop home prices from rising

Jul 12, 2022

THE effects of property cooling measures introduced in mid-December 2021 appear to be short-lived. The Urban Redevelopment Authority’s flash estimate of private home prices for Q2 2022 showed prices up 3.2 per cent quarter on quarter, versus the 0.7 per cent rise in Q1 2022. Year-on-year, private home prices rose 10.3 per cent.



Property consultants such as CBRE and Huttons have raised their private home price growth forecasts for 2022 from 3 per cent to 5 per cent and 8 per cent respectively.

However, homeowners and new home buyers may be in for a rocky ride amid rising home loan rates here. To combat escalating inflation, the United States’ Federal Reserve raised its benchmark interest rates by three-quarters of a percentage point in mid-June. Further rounds of interest rate hikes are expected from the Federal Reserve.

In late June, DBS upped its rates on 2- and 3-year fixed rate home loan packages to 2.75 per cent per annum. About 3 months prior to that, the bank was charging 1.65 per cent for a 2-year fixed rate loan and 1.85 per cent for a 3-year fixed rate loan.

Meanwhile, UOB raised the rate on its 3-year fixed rate home loan package to 3.08 per cent per annum in late June.

However, while rising home loan rates pose a major headwind for the private homes market, some homeowners and potential buyers may feel little impact.

There are cash-rich persons, who do not take up home loans. This includes beneficiaries of successful en-bloc sales, those downgrading from larger homes, and people who buy homes for their children, including those using trusts to buy for minors.

Also, some existing homeowners may have locked in fixed rates at under 2 per cent per annum for some time or made some capital repayments on their loans.

Rising income

Critically, for new home buyers, who require financing, new floating-rate home loans are considerably cheaper than new fixed-rate home loans and the effects of rising interest rates may be offset by rising income.

The 3-month compounded Singapore overnight rate average (SORA) for value date Jul 7, 2022 of 0.87 per cent is up from 0.19 per cent at the start of 2022. A borrower on a floating rate home loan package, who pays 1 per cent plus 3 month SORA, is paying an annual interest cost of under 2 per cent.

In 2021, 14.4 per cent of resident households in Singapore had monthly income from work, including employer CPF contributions, of S$20,000 and above. The average monthly household income from work, including employer CPF contributions, of the second-highest decile of resident employed households was S$20,420 in 2021.

Total wage growth, including employer CPF contributions, among resident employees who have been with the same employer for at least one year was 3.9 per cent in 2021 according to the Ministry of Manpower. The ministry expects the tight labour market to support continued nominal wage growth in 2022.

Take a couple with a monthly household income of S$20,000. A 3.9 per cent rise in income means S$780 more in monthly income. This exceeds a rise of S$451 in monthly home loan repayment should the annual rate interest rate on a 25-year loan of S$750,000 go from 1.8 per cent to 3 per cent.

If the said couple’s average monthly expenditure excluding mortgage payments is S$6,500 and such expenditure rises by 5 per cent per annum, then the rise in household income of 3.9 per cent covers the said increase in both mortgage cost and household expenditure.

Should the couple switch jobs amid a tight labour market, household income may jump by double-digits, which would put the couple in a strong position to cope with rising inflation and interest rates.

But even if home buyers can cope with rising interest rates, the investment case for a buying a home weakens because of rising rates.

Take a buyer who uses a loan to fund 40 per cent of the purchase price of an investment home that generates a total annual return of 5 per cent. Excluding transaction costs, the annual return on equity on a levered basis reduces from 7 per cent to 6.3 per cent if debt costs rise from 2 per cent to 3 per cent per annum.

Capital allocation

Perhaps, a key factor driving capital allocation to homes here is the weakness in other investment instruments. Global equities markets have been rocked by rising interest rates, with the Dow Jones Industrial Average as at end-June down 15.3 per cent from end-2021. Over the same period, Singapore’s Straits Times Index eased 0.7 per cent.

Over H1 2022, share prices of technology giants such as Alphabet (owner of Google), Amazon, Apple, Meta (owner of Facebook), Microsoft and Tesla fell sharply. There has also been a rout of the value of cryptocurrencies such as Bitcoin.

The resilience in home prices here may encourage people who are afraid to catch a falling knife from investing in instruments such as equities - where markets may still be searching for a bottom - to put monies in private homes here.

Still, potential home buyers should be mindful of the risk of Singapore’s economy entering a recession. An analysis of historical data by the National University of Singapore’s Institute of Real Estate and Urban Studies showed that real-estate downturns in Singapore associated with recessions tend to last longer than the periods of economic decline.

But, any economic recession here may be mild and the Singapore government may be able to substantially mitigate the effects of a recession.

Moreover, the Federal Reserve could stop raising interest rates within the next 12 months. Thereafter, interest rates may fall and much of the world may return to an environment of relatively cheap borrowing amid forces such as an ageing population driving liquidity that is in search of investment opportunities.

Over the next few months, potential home buyers here will be lured by several major mass-market launches. The previews for AMO Residence, which will be the first major residential launch in the Ang Mo Kio area in 8 years, started on Jul 9.

Would-be buyers need to carry out more sensitivity analysis to test their ability to cope with rising interest rates. Still, such new homes could prove to be sound investments for those who can ride out the choppy period of rising rates.

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