Thursday 31 January 2013

Inflation and Property Ownership (The Bugle)


Why should property owners and investors care about the inflation rate? The rate at which the prices of a typical basket of goods and services consumed in an economy changes over time is referred to as the consumer price inflation (CPI) rate. Both inflation as well as deflation of prices is possible. Zimbabwe style hyper-inflation caused by excessive printing of money is a case study in how dangerous inflation can be and how it can cause both the financial and real economy to implode in a relatively short period of time. Asset markets, such as a stock market where shares in listed companies are traded or a property market, can be exposed to asset bubbles, which can be just as dangerous as the adjustment in prices can be sharp and sudden. Japan is a country that has experienced deflation over and extended period of time, and this can be equally bad for economic growth. Policy makers therefore have to balance some acceptable level of inflation with the prospect of economic growth and employment levels. 

The direct and immediate impact a change in our CPI inflation has on property owners, is that an anticipated response by the Reserve Bank would be to increase the interest rate it lends to the commercial banking sector (called the Repo Rate), who in turn immediately increase the rate they lend to property owners such as you and me. Higher inflation therefore means a higher cost of money. It also erodes your returns earned on a property investment over time. The nominal capital value of your property would therefore have to keep pace with inflation, failing which you would experience a decrease in the “real” (i.e. inflation adjusted) value of your home. We have experienced real deflation in property values recently where nominal price increases have been below the inflation rate.

As at December 2012 our CPI inflation rate was measured at 6,7%, slightly up from the 6,6% of November 2012, and just over the upper limit of the 3% to 6% target rate adopted by the Reserve Bank. Our 2012 annual inflation rate was measured at 5,6%. This is up from 4,3% of 2010 and 5% of 2011. It is this clear upward trend in inflation that will translate into increases in interest rates at some point. The policy makers may resist increasing rates for a time so as to try and sustain the fragile economic growth and employment figures, but unless inflation is kept below the 6% level, interest rates can be expected to increase and with that the cost of servicing your mortgage bond. The current drivers of our inflation rate have been the food and transport sub-indexes, and to a large extent administered prices such as electricity and municipal rates on property. Food inflation was 6,9% overall for 2012. Transport inflation was 5,5%, but the public transport sub-index was as high as 15,5%, caused mostly by the 12,4% increase in fuel prices. The Housing CPI showed a 6% overall increase but problematic sub-components such as Electricity increased by 10,3%, as Eskom continued to increase its tariffs, and “Water and other services” (including municipal rates) increased by 9,1%. Tenants should take note of this as we can expect a return to the standard 10% annual rental escalation clause in most lease agreements.

(Author: Andreas Wassenaar, published in The Bugle, 30th January 2013)

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