Interest rates to drop
It was not so long ago that I frequently heard people saying “we are in new era where interest rates will never return to pre-GFC levels”. I listened to a bank economist link interest rate spikes to population explosions, like the post World War 2 baby-boom phenomenon. The argument was that if you went back to Egyptian times, on average, interest rates have been a lot lower than pre GFC levels. Therefore, the argument went, it is reasonable to conclude that while the growth rate of the world population is slowing – never again will we see interest rates rise significantly.
Oh how times change…and how quickly it can happen. To be fair, I enjoyed bathing in the confidence of the ‘low interest rates forever’ prophets. But who could have predicted Covid, the supply change impact, labour shortages, Russian madness? If you had told me four years ago what the last 24 months would be like, I’d have thought you were a bit extreme.
Now there is a mess to clean up. Rightly or wrongly the Labour government has loaded NZ with debt, made it hard to find staff to hire and has been slower to open up borders compared to other countries. We are in winter, literally and metaphorically. The winter solstice is 21 June – so the days will get shorter for another week before we start to head towards spring. But there is still a fair bit of winter to journey through.
You get the point. The darkest hour is just before the dawn. Let’s analyse the dark side so we can understand when the sun will rise.
Inflation – the belligerent teenager
Inflation is being a belligerent teenager and refusing to cooperate. It has probably not responded to the OCR hikes as hoped by the RBNZ. Adrian Orr will be frustrated that all eyes are on him, yet the government is not helping by dishing out money with its Cost of Living package, and not enabling more workers to enter the country.
It’s not just a NZ problem. Aussie, the US, Europe, basically the whole world is struggling to bring inflation back under control.
In our last commentary the focus was on when shipping tonnage would open up, and thus put inflation back in its box. While more ships are coming online, we have fresh challenges. It will take time for these impacts to wash through:
- Work Force – the government is slowly making it easier for workers to get a visa. They are even advertising it. However, it will take some months for the Chilean and Brazillian youth to get their soccer balls packed and head over here. At the other end of labour market we have a potential brain drain with delayed OEs starting to kick in. Probably no quick fix to this. The tax reductions enacted by Australia are drawing middle income workers over there – enabling significantly better lifestyles with higher take-home pay.
- Freight – the supply constraint was caused by a lack of labour to unpack and drive containers, reduced shipping tonnage and increased demand for durable goods. The labour force is returning (some early retirees didn’t bank on such high inflation and are coming back to work), tonnage is increasing and now borders are opening, and the travel industry is starting to claw back its share of disposable income from durable goods spending. I believe the tide has turned.
- Government lolly scrambles – I suspect Labour might be wondering if their Cost of Living Allowance has ended up being a bit of an own goal. Many people thought it very unwise given it could drive inflation higher. Therefore don’t expect to see those kind of handouts again.
In summary, there are some fundamental challenges that will take some time to unwind. The good news is, that the unwind is happening.
People are nervous, peering out of the windows, scared about what will happen. Many will feed on the doom and gloom headlines and freeze. That means less house sales, and that means the small to medium sized developers will be hurting. Anecdotally we are hearing of developers ‘dumping stock’. They have to, because the interest on their non-bank loans will start chewing its head off – so they need to cut losses. Some residential sales will be developer stock looking for a quick exit. Those stats flow through to house sale prices.
The down side if this is that there is likely some pain yet to flow through. The good news is that with house prices easing Adrian Orr may feel like there is lees need to hike the OCR. Though that could be wishful thinking if inflation is still running high.
Availability of credit
A combination of CCCFA, loan servicing not working due to higher interest rates and lack of bank appetite all result in credit/ finance being a lot harder to come by. Along with population growth, availability of bank credit is the biggest driver of property price growth.
Bank credit will remain harder to get for some time. However, the govt has already reviewed CCCFA policy and rules are being relaxed. Banks need to lend money to make money. There will come a point where banks will need, not just want, to lend more. When that happens, banks will start relaxing lending criteria…within limits.
I wouldn’t expect much change this year, but 2023 may bring a fresh perspective from the banks.
Interest rate pain
Most banks are forecasting rates to rise through 2022 and into 2023 until they flatten off at the end of 2023 and then start coming back down in 2024. Banks are forecasting an increase of about 150 basis points. Who knows where it will land. The point is that the cost of holding property with debt is going to get harder and harder for the next 18 months…we think. That being the case, this will also fuel the motivation or necessity for some people to reduce debt by selling property.
Once interest rates have peaked and those that can hang on permanently have adjusted, then we’ll see everyone adjust to the new norm.
Interest rate covenants
All banks have interest rate covenants (IRC) on debt. On residential property debt it’s 1.5 times interest cover…generally. On commercial property, most debt at the moment is at around 2 times. The rapid rise of interest rates has caught some investors out, and regardless of whether the investor can afford to hold it, banks are having to have conversations, particularly with developers and commercial investors, asking them to tidy things up. Some can do that by injecting capital, some simply have to sell.
Some banks may pull the IRC back to 1.75 times, but all the big banks are Aussie owned, so I am guessing that will take some time.
There are a lot of wide eyes wondering where all this will end. That translates, as we discussed above, into inaction. This is the time to be bold, but the human psyche finds it hard to do so when there is so much ‘fear chat’ going on.
During the GFC, eventually the scary headlines got a bit boring and the media had to chase something else to grab eye-balls and clicks. The media will gorge on property bad news stories for some time to come. So expect there to be a lack of consumer confidence for a while.
But like all cycles… eventually it will return
My take-out is that there is simply a bunch of ‘stuff’ that has to wash through before we start to see the sun rise and interest rates will drop. I don’t know when, I do know it will happen. And this is the action I recommend:
- Take action early to weather the storm. If things are getting tight -act now, property prices are not going to get better in the next 12 months
- Start buying, or getting ready to buy. There will be some great opportunities coming up.
- Talk to us to help make it happen. We have a buyers agents ready to negotiate on your behalf. We have great property funds to invest in.