Higher-for-longer interest rates will hurt demand for Singapore homes

Oct 03, 2023

IN RAPIDLY ageing Singapore, many may welcome the rise in interest rates. A retiree who lives on passive income may find the higher returns on Singapore dollar fixed deposits or Treasury bills helpful in coping with the rising cost of living.

Higher interest rates are generally a bane to real estate players, though. Developers face higher financing costs, which hurt profitability, while those with high gearing could run into cash flow difficulties.

Landlords face a double whammy of higher financing costs reducing net income, and falling property valuations due to the use of higher discount rates to value projected future cash flows.

Homebuyers who borrow to buy a dream home are also affected by higher home loan rates.

The three-month compounded Singapore overnight rate average (Sora) has risen from 0.2 per cent per annum in early 2022 to 3.7 per cent as at value date Sep 29. The annual interest cost of a home loan that is priced at 1 per cent plus three-month Sora has thus risen from 1.2 per cent in early 2022 to 4.7 per cent today.

The possibility of interest rates staying high over a prolonged period could significantly affect demand for private homes here.

First, many buyers buy uncompleted new homes off-plan using the progressive payment scheme because they do not need to take on much debt financing for possibly two to three years – until the home is completed. In the first six months of this year, developers sold 3,233 uncompleted homes. These accounted for 34 per cent of total private homes sold in Singapore.

Under the progressive payment scheme, buyers pay an upfront payment, followed by other payments according to construction milestones, with full payment made at or after completion.

Buyers of uncompleted homes can benefit if home loan rates are much lower in two to three years. Conversely, if a buyer assumes a higher annual home loan interest rate in future of, say, 4.25 per cent, and not 3 per cent, this can substantially impact what is deemed affordable.

The monthly instalment on a S$1 million loan with 25-year tenure of S$4,742 rises by 14 per cent to S$5,417 based on annual interest rates of 3 per cent and 4.25 per cent, respectively.



Financial impact

Second, higher home loan costs weaken the financial case for a buyer using leverage to fund a home purchase.

Take a buyer of a S$1.5 million home, who funds the purchase with S$500,000 of equity and a S$1 million loan with 25-year tenure. Total mortgage payments made over 25 years amount to S$1.42 million and S$1.63 million, respectively, based on annual interest rates of 3 per cent and 4.25 per cent.

Assuming annual price growth of 4 per cent, the home is worth S$4 million in 25 years. After accounting for financing cost, the profit works out to S$2.08 million and S$1.87 million, respectively, based on annual interest rates of 3 per cent and 4.25 per cent. This is either 4.2 times’ or 3.7 times’ equity.

Third, a homebuyer who assumes a higher home loan rate may have to lower his budget for a home purchase.

A buyer who is fine servicing a monthly instalment of S$4,742 can take up a S$1 million loan for 25 years based on an annual interest rate of 3 per cent.

If the annual interest rate is 4.25 per cent, the size of the loan will have to shrink to about S$875,000 in order for the monthly instalment to remain at S$4,742.

Fourth, a residential property investor who relies on rental income to cover mortgage payments may see his calculations upended by higher interest rates.

The landlord may face problems in loan servicing, especially if the rental market softens or a unit is vacant for some time.

While potential investors in Singapore homes largely hope for capital appreciation, factoring in higher home loan costs into the decision-making process can lead some to walk away from signing on the dotted line.

Cash-rich buyers

Fifth, higher interest rate expectations will also weigh on potential buyers who are cash-rich. With higher interest rates, instruments such as bonds and fixed deposits pay better returns.

Some cash-rich people may opt to invest in such instruments instead of buying a home. Singapore’s latest six-month Treasury bill offered a cut-off yield of 4.07 per cent in the auction that closed last week.

Even those who are cash-rich may hope to fund a small portion of a home’s purchase by debt, so higher debt costs have an adverse impact on such persons too.

Also, many people are swayed by market sentiment. If higher interest rates for buyers who rely heavily on home loans take the fizz off new home sales, expect cash-rich potential buyers to be less motivated to make purchases.

There are many good reasons to buy Singapore homes. Political stability, good infrastructure, stable supply and a growing economy are among them.

Still, where interest rates go matters greatly to housing demand – which is largely from local buyers. For people who borrow to buy a home for living in, higher home loan costs crimp purchasing power. For people who buy for investment, the investment case weakens when interest rates rise.

The private home price index rose 0.5 per cent in Q3, according to flash estimates by the Urban Redevelopment Authority, following a 0.2 per cent fall in Q2.

The average quarterly rise of around 0.2 per cent over the past two quarters was lower than the average quarterly increase of 2.1 per cent in the whole of 2022.

Expect expectations of interest rates staying higher for longer to cast a long shadow on the Singapore private residential property market.

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