The rising opportunity cost of property investment

Silvan Mifsud is director of Advisory at EMCS Tax & Advisory

As outlined in previous articles we are coming out of a prolonged period of low inflation and low interest rates. The first graph outlined below, depicts the trajectory of the yields on a 10-year-old AAA sovereign bond in Europe. One can see that such yields began a downward trajectory in 2014 and remained very low, sometimes even in negative territory, all the way until 2022. This was the result of a looseing monetary policy in an attempt to boost economic growth and demand, as various European economies failed to grow following the 2008/9 events. At the time the ECB went beyond just lowering interest rates but also started the infamous quantitate easing, which basically meant that it was increasing the money supply.

The end result of all this was that returns on fixed income investments was very low or almost non-existent unless one invests in riskier high yield bonds which delivered a higher yield but at substaintially higher risk.

This also meant that many Maltese investors had for this outlined period between 2014 to 2021, to either resort to investing in equity or otherwise shift completely and invest in property to gain a better return. It is a known fact that many decided to look at the property market as a lucrative investment, especially since the influx of foreign workers boosted the rental property market, delivering interesting returns of investment.

The end result was quite predictable. As shown below the dwelling permits issued by the Planning Authority started a strong upward and increasing trajectory from 2014 onwards, peaking in 2018 and 2019, prior to the advent of Covid-19.

However, since the beginning of 2022 things have now changed. Inflation started rising first as an aftermath effect of the pandemic, due to a misalignment between global demand and supply and then the war in Ukraine fuelled inflation even further. To combat inflation the ECB, like other central banks, has been increasing interest rates and is indicating to continue doing so, at least in the near future. This means that the opportunity cost of property investments is on the rise. When one considers the lead time, effort, issues with labour supply shortages and issues with rising material costs, the attractiveness of returns from property investments are likely to become less attractive when compared to a few years ago. This besides that financing property development is likely to become even more expensive as rising interest rates will mean that the cost of borrowing funds to finance property investments will increase.

So far, the attractiveness of property development has been maintained due to a relatively strong property rental market. I feel it may be uncertain as to how much this property rental market will remain as strong as it has been until now, especially if policymakers realise that Malta’s economic growth cannot rely on an endless influx of foreign workers. At the end of the day, a break in the spiralling prices of property due to a dip in demand, may not be the worst of news.