Advice and Opinion

The effect on the commercial property industry with interest rate hikes

An interest rate hike is never good news for anyone, except for those with cash invested in the bank. Nevertheless, they do occur and investors in the property market should be aware of how this will affect them.

Jason Gregoriades, a member of the Rawson Property Group’s Commercial Business Development Team, says its important to first look at the challenges of commercial property investment but always bear in mind that there are many benefits too.

“When considering commercial property to begin with,” says Gregoriades, “one must realise that the deposit required by the bank, which is approximately 30 to 35% of the total loan, is far greater than what is required for a residential property (approximately 10%). In addition, getting finance for commercial property requires your property portfolio’s net income to service the bond instalment.”

Secondly, the lending rate is higher in the commercial sector, generally at prime plus 1.5%. While in the residential arena, the rates can be as low as prime -1%. Further to that, the term of the bond is far shorter for commercial property, and due to these variables, the monthly repayments will always be higher on commercial property. However, residential property, though seemingly easier on the pocket at face value, is affected more acutely by an interest rate hike due to the longer duration of the bond.

“To illustrate my point,” says Gregoriades, “I would like to use an example of a commercial property bond of R1 000 000 over a period of 10 years at prime -1%”

Subject to an interest rate hike of 1%, explains Gregoriades, this bond would see a monthly instalment increase of R581. While a residential property with a bond of R1 000 000 over 20 years at prime plus 1.5% would see an increase of R657. As a result of the interest rate hike, the owner of either property, if they choose to rent it out, would have little recourse but to increase their rental in order to cover the increase in bond repayments which will ultimately have an influence on their tenant.

“An important point to consider when comparing property investments for letting purposes is the nature of the tenants that will be leasing the respective property types,” says Gregoriades. “For example, business enterprises leasing space in a commercial property will be income-generating and even faced with an increase in rental, will have several options to make up the extra amount required. They could up their work load or client base to generate more income, cut operating costs and operate more efficiently, or pass the higher cost on to the consumer, as often happens with some of our national retail chains.”

In contrast, adds Gregoriades, a residential tenant will more than likely be a family of two adults, one or both of whom are salaried employees, expected to produce the same or better results from a remuneration package which is capped and offering no increase.

“A rise in rent and no rise in salary,” says Gregoriades, “could see the tenants decline the renewal of the lease when it expires and seek more affordable accommodation elsewhere, which would be a great pity to the residential investor, pre-supposing they are good and reliable tenants.”

It is important to note that tenant leases also differ in duration between residential and commercial properties. Residential leases are usually renewable annually while commercial leases are likely to run for three or more years. This longer term stabilises tenant turnover as well as the tenant’s need for a constant address, a necessity for customers to remain familiar with their location.

Changing business premises, says Gregoriades, can be a tremendous disruption to existing business practice. The reprinting of stationery, notifying of clients, changing of telephone numbers, decorating of new premises and loss of income, are all deterrents to be considered when a commercial enterprise considers relocation. Due to this, a commercial tenant will be far less inclined to move to new premises and more flexible when faced with an increased rental than a residential tenant would be.

“Obviously the above only works if the commercial landlord has secured a good tenant”, concludes Gregoriades, “but this is no different in the residential space. Even if both secured a good tenant, I would argue that the residential tenant is bound to buckle under the pressure of an interest rate hike first, long before the good commercial tenant, who had more options available to them to absorb the increase.”