Navigating interest rates and lending criteria for property investors

Financial literacy is critical for property developers. It can mean the difference between smoother success and having to learn some tough lessons through bitter experience. Crucially, property entrepreneurs need to understand two key aspects of their investment journey: managing interest rate fluctuations and meeting lending requirements.

Property prices tend to rise when interest rates fall and drop when rates go up - it's a common inverse relationship. While stable rates support steady property values, investors should also look for interest rate levels that make properties affordable to sustain and easy to resell, if ever necessary.

For the sake of context and to position where South African entrepreneurs currently stand with regards to interest rates, let’s briefly look back five years. Interest rates (using the prime rate as a proxy) fell to their lowest in 2020 (7%) when there was a need to stimulate business activity following the Covid-19 pandemic.

They were subsequently hiked to a peak of 11.75 % in 2023 as a measure to curb inflation. Since then, inflation has largely been under control, and there have been, and still are, pressures to kick-start growth. Thus, there has been a fall in rates of almost every quarter by 25 basis points. The most recent falls in the interest rate have seen a resurgence of business activity in the property market. Since 2024, we have been seeing more and bigger transactions happening. While interest rates will undoubtedly fluctuate over a loan's lifespan, being forewarned enables entrepreneurs to respond accordingly.

Managing interest rates wisely begins at the point of acquisition, by buying well. Optimally, the acquisition cost should be low and the yield high, ideally substantially higher than the cost of funding the property. That way, if a property entrepreneur leverages, they can benefit from a positive multiplier effect of borrowing on their return on equity. The converse is true for low yield and high cost of funding, where property entrepreneurs end up carrying the project with a lot of equity to make the project work.

It's important to note that buying well doesn't mean entrepreneurs can turn a blind eye to their level of debt and debt service or interest cover. I recommend acting conservatively and aiming for a good debt service cover, which is at least 1.3 times the instalment. Furthermore, the loan-to-value should also be conservative, below 80%.

This helps property entrepreneurs in the event of distress, enabling them some headroom to cover their liabilities and weather the effects of interest rate fluctuations. As mentioned, interest rates inevitably rise and fall, but there are several strategies to manage cash flows when interest rates are high. These include asking to service interest only during high-interest rate periods; asking to reset the loan and pay over a longer period in smaller instalments, and thirdly, injecting capital by selling lower-yielding investments and settling expensive debt, provided you don’t have early settlement penalties.

It’s not prudent to have idle cash while servicing expensive debt. Another strategy is to review rentals to improve income. Doing so could help increase net operating income and debt service cover ratio. A final way to weather high interest rates is by reducing one's running costs through greening and other cost management measures, which increases the net operating income and debt service cover ratio. It is equally important to understand lending criteria and what has changed in response to the current economic climate.

Even as availability is there, three pitfalls can lead to being denied a loan. The first is failing to invest time in understanding the market or the complexity of the property projects and presenting assumptions that are not viable. Secondly, if a property entrepreneur's credit profile and background do not reflect their capacity and the required good commitment and integrity to honour their commitments, they will likely be denied. And finally, lack of compliance with the required personal financial management, tax compliance, and FICA documents will lead to TUHF being unable to offer a contract.

Understanding the dynamics of interest rates and lending criteria is crucial for property investors. By staying informed and adopting strategic approaches, property entrepreneurs can demonstrate they are prepared for property investment and management and their ability to navigate the complexities of the market.

* Chikomo is a senior portfolio manager at TUHF.

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