Tuesday, September 25, 2012

QE3: Implications for our property market

The Business Times - September 22, 2012

Unless further draconian policies are enacted or creative mechanisms thought up to counter liquidity, prices are expected to be biased on the upside

SINCE the announcement of the third round of quantitative easing (QE3) by the US Federal Reserve last week, many people are asking what impact this measure has on Singapore's property market. This piece tries to answer that question, based on the experience of what happened to interest rates after the previous two rounds of quantitative easing.

QE3 brings with it expectations of further property price increases and attendant fears of curbs. Are price increases really the only end-game or is the outcome something different from the norm. Before we proceed further, we need to take a step back and digress to ask what quantitative easing is.

Quantitative easing has been a series of easing measures initiated by the Fed. The first, aptly named QE1, began in November 2008 when the US central bank started buying mortgage-backed securities. By the time it concluded in March 2010, US$1.25 trillion of such securities, US$300 billion in Treasury bonds and US$175 billion of federal agency debt had been purchased.

QE2 began in November 2010 when the Fed continued to reinvest payments on the securities purchased during QE1. It also purchased US$600 billion of long-term Treasury securities. The second programme ended in June 2011.

Fund flows

What had QE1 and QE2 achieved? In general, both brought interest rates down and exported liquidity to Asia where the economies were in much better shape than those in the West. The impact of the easing measures had hardly any impact on the real economy for the United States.

So what is QE3? It is a variation of the earlier rounds of easing, but with a more regular pace of mortgage-backed securities purchasing planned at US$40 billion per month with no deadline. The Fed also pledged to maintain fed funds rate near zero at least through 2015.

Before we head off to look at the impact of QE3 on our property market, we may wish to take a look at what the previous two rounds of easing did to local interest rates. Figure 1 shows how Singapore's three-month interbank rate reacted to the two QEs. While the effect QEs had on interest rates is undeniable, such information is nevertheless of little value.

Figure 2 throws up more information as to the behaviour of interest rates in the periods during and in-between the various QEs. Although we only have two periods to look at, we can nonetheless form an opinion of how interest rates may react to QE3.

Figure 2 shows that interest rates here reacted only during the period QE1 was in force and not to QE2. One possible reason we believe was that when QE1 was announced, the market may have been taken by surprise. This led to a massive 193 basis-point (bp) decline in the three-month USD Sibor during the 16 months when QE1 was on. Our three-month interbank rate also fell, but only by 12 bps. Having learnt what the Fed could do, the market became anticipatory and when QE2 kicked in, interest rates didn't move during its tenure. The three-month USD Sibor fell only by five bps whereas our three-month interbank rate didn't budge at all.

What all this may imply is that interest rates have already started responding to QE3 et al since June 2011, well before the actual announcement. However, because this time round the QE is extended indefinitely, as opposed to the previous rounds which had a shelf life and in particular with reference to QE2, interest rates could still adjust down post-announcement.

Before moving on to forecast interest rates, let us look at what happened to our real estate prices during the period of the previous rounds of QEs.

Figure 3 shows that since 2009, low interest rates, among other factors such as population increases and the introduction of shoebox units, have kept overall private residential prices up. For commercial properties, prices have also held up well despite the continued deleveraging in the banking sector. Industrial property prices have seen a stellar rise during this period, arising from liquidity flowing into the sector from the residential sector due to the implementation of a series of cooling measures.

Although not rocket science, using a simple curve fit as a forecasting tool, our three-month interbank rate is forecast to fall further. Figure 4 shows the actual and forecast of interest rates from Sept 14, 2012, until Q4 2013.

From Q2 2012 until Q4 2013, interest rates are forecast to fall an average of 27 bps. What impact does this have on the various property asset classes? If financial institutions keep the same loan spreads, Figure 5 shows the impact on asset values for four major sectors of our real estate market, namely prime grade A offices, luxury non-landed residential, multi-user industrial space and shops in both the central and fringe area.

Therefore, keeping all things constant, prices for these four major real estate classes are expected to perform positively but at varying rates of increase. The point to understand is that those asset classes which are already sporting low yields will benefit more with a cut in interest rates than those with higher yields.

With the exception of shophouses and Good Class Bungalows, luxury non-landed residential properties have at the moment the lowest yields among all real estate classes and sub-types. They are expected to benefit most from any decline in interest rates.

Various factors

Whether it's the effect of QE3 or other local or regional factors, conditions here still favour property prices to rise for the rest of this year and next.

As earlier discussed, the potential impact of QE3 ad infinitum is creating the conditions for asset values to increase. Interest rates may fall even more if banks decide to lower interest margins on their loans, particularly to end buyers. This, however, may meet some resistance because local banks are already sporting net interest margins of less than one per cent for their Singapore operations.

On a separate but related point, prices can be further boosted by developers' optimism who, because of instinctively responding to QE3, bid more aggressively for land. The land cost push factor would then be layered on top of the price increases highlighted earlier mainly from the impact of lower interest rates.

Fortunately, the very fear of policy intervention may work to "sterilise" or tamper developers' optimism, leaving the just interest rates to work on the end-product prices, that is new home sales and resale prices. This is unfortunately a policy issue and thus unpredictable.

Over the longer term, the inflationary impact of QE3 on our property market may be tampered if after a period of time, the US economy still does not respond and this indifference is exported to Asia. However, in the immediate term, with our economy running at low unemployment levels, the population still increasing significantly and developers offering smaller format homes that come with a lower price quantum, we may still be shielded from the problems in the US economy.

On balance, unless further draconian policies are enacted or creative mechanisms are thought up to counter the liquidity from QE3, prices are expected to be biased on the upside for the rest of this year and 2013. This positive bias is predicated on interest rates here falling further in response to the continued liquidity injection of QE3 AND that this interest rate decline is passed on through lower borrowing costs.

Martin Koh | 86666 944 | R020968Z
Sherry Tang | 9844 4400 | R020241C
Senior Sales Director
Email: marshe_inc@yahoo.com.sg
DTZ Debenham Tie Leung (SEA) Pte Ltd (L3006301G)

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