Higher interest rates are not discouraging homebuyers, but a lower borrowing limit might be

According to market analysts, if interest rates reach 4% or higher, the demand for real estate could reach a tipping point.

Aug 19, 2022

The price is determined by supply and demand. According to economic theory, higher prices should reduce demand, thereby increasing supply. However, Singapore's red-hot real estate market has defied such expectations for months.

The Urban Redevelopment Authority (URA) reports that private residential property prices increased by 3.5% in the second quarter of 2022, following gains of 0.7% in the first quarter and 10.6% for the entire year of 2021.

SRX data showed that HDB resale prices increased for the twenty-fifth consecutive month in July. The most expensive HDB resale transaction on record, a 5-room loft unit sold for S$1.4 million at [email protected], also took place during the month.

In spite of this, Singapore's population has decreased: from 5.9 million in June 2019 to 5.45 million in June 2021.

What is the cause of the robust demand? And is there any way to quell it?

According to market observers, buyers are a mix of new families and investors, some of whom own multiple properties. As interest rates rise, this latter group may find it difficult to generate a profit from their property investments.

Buyer demographics

The pandemic is frequently cited as a reason for the property market boom over the past year. In order to meet their immediate housing needs, buyers have turned to the resale market as a result of delays caused by Covid-19 restrictions on new construction.

According to Derek Tan, head of property research at DBS Group Research, the Covid-19 years should be evaluated in light of buyers who may have postponed purchases in 2020 until the following year.

He adds that there may have been pent-up demand and that returning Singaporeans would need a place to stay.

In the meantime, household sizes have decreased. Professor Sing Tien Foo, director of the Institute of Real Estate and Urban Studies (IREUS) at the National University of Singapore, asserts, "More small families also means a substantial increase in housing demand."

However, he believes that these fundamental demand drivers do not fully explain the purchasing behavior. "It is difficult to predict how many of these individuals will purchase a second, third, fourth, or fifth home for investment purposes."

Christine Sun, senior vice-president of research and analytics at property agency OrangeTee & Tie, asserts that the proliferation of 1- and 2-bedroom units in recent years has enabled investors to acquire more properties.

"We don't have the statistics to prove this," she says, "but if you turn left and right, you will find that many people own multiple properties." It is easier for individuals to acquire a second or third property as a result of the more affordable price levels.

In recent years, the extremely low interest rate environment has supported demand without a doubt.

Prof. Sing states, "This is a crucial factor." "This 1-percent-or-less type of interest – a teaser rate – causes a great deal of price inflation, and then people enter into it with hope."

A developing storm?

In his National Day message, Prime Minister Lee Hsien Loong stated that it is unlikely that the world will return to the low inflation and interest rates of recent decades.

Indeed, these prospects should give owners of multiple properties a great deal to unpack – and to worry about.

According to Professor Sing, even a 1% increase in interest rates could have a "substantial impact" on the monthly mortgage payments of homeowners, depending on the amount they borrowed from the banks.

MoneySense's mortgage calculator reveals that a 30-year, S$500,000 fixed-rate loan with an annual interest rate of 1% would require a monthly payment of S$1,608.

When interest rates increase to 3%, monthly repayments increase by 31% per month to S$2,108, which is significantly more than the average annual wage increase.

If interest rates were to increase to 5%, the borrower's monthly payments would rise to S$2,684 (a 66.9% increase).

Beyond the immediate impact on one's monthly cash flow, one must also consider the impact on the loan's amortisation schedule.

Darren Goh, executive director of MortgageWise.sg, explains that the proportion of principal reduction and interest in monthly payments will affect borrowers.

"When (the interest rate is) 1.5% – and many of us are very accustomed to this – your loan balance decreases very quickly because... nearly 70% of your monthly payment goes toward principal reduction, while only 30% is interest," he explained. "If it is 3.5%, it swings in the opposite direction."

Even with all these possibilities of a looming increase in debt, many market observers appear unconcerned – at least for the time being.

Early in August, data from the MortgageWise website indicated that banks' variable rates ranged from 1.9% to 2.1%.

The current interest rate level is still quite manageable, according to OrangeTee's Sun, who notes that rates reached as high as 2.5% in Q2 2019 and that the current rate is still quite manageable.

Sun notes that the majority of purchases in Singapore are still HDB flats, with a median resale price of approximately S$500,000.

Based on a loan-to-value ratio of 75% and a 30-year loan, an increase in interest rates from 1.9% to 3% would increase monthly payments by approximately S$214, to approximately S$1,581.

The numbers may indicate a 16-percent increase in monthly payments, but this should be viewed in the context of dual-income households, so the actual impact on one's finances may be less.

"Borrowers may utilize both CPF and cash, and you're discussing (income from) husband and wife," she says. The increase of S$214 may not be significant.

According to the Singapore Department of Statistics, the median monthly household income from work in Singapore increased by 3.6% per year in nominal terms to S$9,520 in 2021, surpassing pre-Covid-19 levels

Last month, Monetary Authority of Singapore (MAS) managing director Ravi Menon stated that Singapore's household debt situation "remains generally healthy."

Singapore's stringent property loan borrowing requirements will also keep this in check.

The total debt servicing ratio (TDSR) in Singapore limits a borrower's total debt obligations to 55% of his or her income.

This ratio is determined by calculating mortgage obligations using either a 3.5% interest rate or the current market rate, whichever is greater.

"The TDSR serves as a sort of cushion or buffer against over extending leverage," says Leonard Tay, head of research for the Singaporean real estate firm Knight Frank. They have sufficient financial cushion to withstand a rise in interest rates without experiencing a financial collapse.

The median TDSR for new loans issued over the past year, as reported by the MAS, was 43%. As of the first quarter of 2022, the loan-to-value ratio for the outstanding mortgage stock was less than 50%.

The stress tests conducted by the central bank indicated that the majority of households "should be able to service their debts even under scenarios of sharp interest rate hikes and significant income losses."

According to DBS's Tan, property prices have a stronger relationship with employment and economic performance than with interest rates.

Additionally, he notes that some owners would have locked in fixed rates when they were lower, and that the impact of higher rates would not be felt until much later.

He states, "I'm not aware of any sellers who are feeling unduly pressured due to the current employment climate."

Booming rentals

Homeowners' anticipation of stable rental yields contributes to the optimism.

Lim, a property investor with a similar outlook, owns four titles, two of which are fully paid for, primarily in the central area.

Lim, who requested to be identified only by her surname, asserts that there has been ""incredible demand" in the rental market.

She notes that interest rates have historically been higher than 6 to 8 percent. "Inflation is already so high, so if one day it reaches this level, I will have no choice but to increase the rent, and I believe other landlords will do the same in short order," she continues.

According to market analysts, owners have been able to increase rents without much difficulty due to the current rental market's robust demand and lack of available units.

The URA rental index, which has remained relatively stable since 2017, began to increase at the beginning of 2021. During the first half of this year, it increased by approximately 11,2%. Additionally, the vacancy rate for completed private residential units has remained relatively low at 5.4%.

According to Tay of Knight Frank, rents have been driven by both domestic and international demand, with rents increasing faster than property prices.

"There's so much stress with new people moving in, existing people whose houses are delayed and whose completion is delayed, and they have to rent," he says.

Observers of the market anticipate that owners like Lim will not be forcibly removed from the market, so property prices should remain high.

According to DBS's Tan, marginal buyers, such as upgraders, are more likely to reconsider their purchasing decisions.

He anticipates that the second half of 2022 will be weaker than the first, but believes that this will be reflected in volume rather than the overall price index.

"If you ask me whether a Dawson flat's asking price will drop from S$1 million to S$900,000, I'd say it's possible, but I don't believe it will happen overnight," he says, referring to the HDB estate in Queenstown, where a number of million-dollar flats have changed hands.

Knight Frank anticipates that private residential prices will increase by 5 to 7 percent for the entire year of 2022, exceeding the initial "conservative forecast" of 1 to 3 percent when new property cooling measures were announced in December of last year.

While home prices have maintained a steady uptrend thus far in 2022, volume has slowed significantly. The number of private residential units transacted in Singapore for H1 2022 decreased by 26.6% year-over-year and by 28.5% compared to H2 2021.

The Sun of OrangeTee observes that HDB flat prices have not decreased despite the fact that they began to rise last year.

The increase in interest rates is still quite gradual, which may explain why buyers have not pulled back or purchased smaller units. She says we have not yet encountered such a circumstance.

HDB data revealed that HDB resale volumes declined by approximately 6.1% annually in the first half of 2022.

The actual pain

Sun notes, however, that interest rates and cooling measures are intertwined, and if the TDSR continues its upward trend, interest rates could have an impact on the index.

If TDSR is calculated using a higher interest rate of 4.5%, the affordability of housing for many people would be "significantly" impacted.

She says, "It will affect both the HDB market and the private market." When they reach that level, I believe TDSR will have a greater impact on the market than interest rates.

A change from 3.5% to 4.5% for TDSR calculations would reduce the maximum loan amount available to buyers by 11.4%, according to calculations performed by The Business Times, assuming a 30-year loan, stable household income, and TDSR cap.

Several market analysts consider an interest rate of 4% to be a tipping point for the real estate market.

In an H2 market outlook report, Cushman & Wakefield analysts noted that demand may be affected if medium-term interest rates rise above 4%. However, they believe that the risks of a severe price decline may be limited absent additional cooling measures and an unanticipated worsening of economic conditions.

DBS's Tan states, "The issue arises only when the rate exceeds 4%." This is where I believe households will be somewhat strained."

Even if mortgage rates rise above the 3.5% threshold used to calculate TDSR, Tan does not anticipate that they will remain above that level for an extended period of time.

Goh, from MortgageWise.sg, is optimistic about the future of interest rates and advises buyers to study the interest rate cycle rather than panic or lock themselves into higher-than-expected fixed rates.

In the first half of the year, he notes that it was a "no-brainer" to go with a fixed rate when interest rates were below 2%.

"The second half is less clear," he explains. "By September, we anticipate (the 3-month compounded Singapore Overnight Rate Average) to reach the range of 1.5 to 1.8." This would result in variable rates in the range of 2.6% to 2.7% by the end of the year, as well as the possibility of rates reaching the TDSR threshold of 3.5%.

However, he anticipates that central bank tightening will eventually have an effect on inflation.

"Accordingly, we believe that (interest rates) will decline in 2023 due to the (US Federal Reserve's) pace."

Prof. Sing of IREUS is concerned about those who may have exceeded their loan-to-value and TDSR limits.

"I believe that is quite risky," he says. "It doesn't matter if this increase is a one-time event, but I believe that interest rates will continue to rise over the next quarter or even the next year or so, given the current rate of inflation."

For home purchases, he advises buyers to exercise caution and prudence and pay close attention to their affordability levels.

"Why are you in such a hurry to enter?

People are purchasing as if the market will rise further... "However, if you examine the past, you will notice that prices fluctuate," he says. It can be brought down.