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US interest rate rise could dampen global property markets like Hong Kong and Singapore

This is because it will most directly impact currencies with dollar or basket based pegs which will see interest rates dragged upwards in parallel with the dollar, most notably the Hong Kong and Singapore dollars, according to international real estate firm Knight Frank.

In a new analysis report it explains that in both of these markets residential properties have benefited from cheap credit over the last few years. ‘Holding everything else equal, an increase in interest rates will have a dampening effect on these two global cities as the cost of debt increases. We could see sales volumes compromised as new purchasers see mortgage rates rise, and the attraction of property as an investment recede slightly,’ it says.

‘However, cooling measures that we have seen put in place in both Hong Kong and Singapore could counter balance these impacts. The measures provide policy makers with the opportunity to try and re-inflate demand if market corrections prove too much. A reversal or softening of some of these temporary policies could therefore be a very real possibility,’ it adds.

The report also points out that in terms of the net impact on pricing, house prices are not only influenced by interest rates, but also by fundamentals and other factors. ‘Economic performance, existing and upcoming supply and policy changes will have a bigger impact on house prices than changes in interest rates alone,’ it says.

‘If the fragile global economic situation continues, hard income yielding assets such as property will continue to do well; on the other hand, if the global recovery gains pace, property will again benefit from growth,’ it adds.

In emerging Asia, although less impacted directly by rising interest rates in the US, further capital outflows could put pressure on domestic economies and therefore residential property prices. Domestic economic performance will therefore be the key set of indicators to monitor, it also points out.

The report explains that commercial property investors tend to be more sophisticated than typical individual residential investors and it is likely that the prospect of a number of interest rate hikes will have already been modelled and priced in by the major players in the market.

‘The short term impact is therefore unlikely to be significant, although pricing could be impacted especially if we see a number of interest rate hikes next year,’ it continues.

It also explains that the sheer weight of capital that continues to target global cities around the world has compressed prime yields to historic lows in many markets and as the cost of debt increases, spreads between property yields and debt will be squeezed.

‘Over time, the resulting impact could lead to some upward pressure on yields and a re-focussing on rental growth, which will mean that cities with strong performing economies and employment markets will be best positioned going forward,’ it adds.

And it states that while the pace of interest rate rises in the US are still difficult to determine, higher global interest rates will begin to put upward pressure on cap rates as the cost of debt rises. In this scenario, one important consideration is what rental growth an investor would have to receive to maintain a specific internal rate of return (IRR).

The graph illustrates this, showing the rental growth required to maintain an assumed IRR target of 10%, given various entry cap rates and a range of cap rate increases.

‘Given the trend to allocate a larger share of investment portfolio to real estate, it remains to be seen how yields will react. However, if yields do decompress, investors would require significantly higher rental growth to maintain their return targets,’ the report concludes.

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