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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