Low interest rates: How much lower and for how long?

The article below first appeared in last Friday's edition of the TODAY paper.

After reading the report in The Straits Times today about our local banks offering rock bottom rates for selected new projects, the wife and I felt it apt to revisit the TODAY paper's article:

Will history repeat itself?
These days, when I am asked in casual conversations about the local housing market, I am at a loss for words.

Do I describe the market assuming that housing interest rates remain as they are, which has been abnormally low for about two and a half years now, or do I launch straight into the explanation of rates and describe how they have been underpinning the entire property market today?

Either way, the listener is bound to be misled or confused as he is expecting me to just talk about demand and supply.

However, what drives our market today is not simply demand and supply but interest rates - or the cost of money - as well. Increasingly, the market may continue to rise or correct just on interest rates alone - neither supply, nor demand.

But you may ask, what is the big deal about interest rates? When the banks are flush with liquidity, promotional housing loan rates for the first year are very low, sometimes provided at cost. That is, the bank charges you the same rate as it pays its depositor on his or her cash deposits with the bank and earns nothing. That is how much money banks have today.

Such low rates reduce the monthly mortgage payments to almost its minimum. Where previously, households struggled to purchase a million-dollar property, it is now within the reach of many more people - for the first few years anyway, never mind whether these households can eventually pay off the mortgage or not.

In property-obsessed Singapore, many buyers take a short-sighted view: Future problems are tomorrow's problems. Let us focus on today; who knows what will happen tomorrow? Prices may shoot up and I can just re-sell my property for a tidy profit.

Not being able to afford the monthly payments or pay off the mortgage is no longer an issue. This isn't a problem if this is limited to only a few households, but if the majority of buyers act this way, who do owners sell onwards to?

So many more people than before own more than a single property these days. But who really owns all these new property purchases? For the next few years at least, in reality, it is still the bank.

What about renting it out if you cannot sell it? Again, low interest rates and low holding cost distort market behaviour in the leasing market.

Suppose rental demand is not as buoyant and, as a result, rentals are flat and may even be poised for a correction. But rental yields or returns rise when interest rates fall. This is because the cost to the landlord is falling in terms of having to pay less in terms of interest cost on his housing loan. And rates may be falling faster than rentals are correcting.

So, what is the correct decision - to buy or not to buy? The people closest to the prospective buyer, namely the housing agents and bankers, are not likely to give sound advice or even warn of future potential pitfalls, because they depend on the commission from the purchase for their bonus.

What comes down, can go up
Those of us who are not swayed by the transient allure of the low-interest rate environment try to warn of the dangers of a potential sharp interest rate hike but this advice is falling on deaf ears.

If you trace the recent history of interest rates, there was also a bout of low rates occurring in 2002 up to the middle of 2004 (see chart).

However, the rates were not as low as today's and not as consistently flat as today's. It is almost like the animal that is the interest rate, no longer has a heart beat.

Also only a few seasoned property investors remain who remember the period - towards the end of 2007/start of 2008 - when interest rates rose not only sharply but almost to a new high.

Many multiple-property investors and speculators then were having sleepless nights. For those living at the edge or those highly geared, one by one, the properties went until they were left with just the roof over their heads.

Out went the luxuries, the fancy cars, the club memberships and so on. The super rich or those with lots of cash reserves were not affected as the spike did not last too long but it was a painful lesson for those whom I can only describe as people who are not there yet, but who aspire to be among the ranks of the rich. It is this group I am most worried about.

For most of the people in this group, this episode is either ancient history or they were not in the market then. If you have spoken to one of the veterans who lived through this traumatic period, you would know that words cannot even begin to describe the panic, desperation and pain they experienced, not just for themselves, but for their families as well.

Source: Colin Tan (Head of research and consultancy at Chesterton Suntec International)

The wife and I can certainly appreciate the warning, after having lived through the "traumatic" period in 2007/2008, where interest rates shot up to almost 4% and watched the monthly loan repayment amount of our two mortgages increasing month after month.

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