The impacts of more than a year of RBA rate rises have been felt across the nation’s property markets, with mortgage repayments up, more people facing the threat of defaulting on loans and listings down as potential sellers wait for some certainty and stability in the financial environment.
So how do interest rates affect property investors?
The most obvious effect is that rising interest rates mean higher repayments required to service a loan. If you already have properties you are servicing, your margins may have been squeezed significantly by 4% worth of rate rises in just over a year.
Say you were paying 3% on a loan and are now paying 7%… that’s an extra $4000 a year you must pay for every $100,000 worth of loan you have. For many people, this could be enough to turn their portfolio from positively geared to neutral, or even negative, which would mean needing to find extra money to put into your loan repayments each month rather than having your properties take care of themselves.
The other effect on borrowing is the raised barrier to entry. If you want to borrow money to buy a new investment property, the amount the bank will give you will have substantially decreased since April last year. As a general rule, you could expect to be able to borrow about 30% less. So if you were looking at purchasing a property worth $400,000 last year, you might need to re-set your expectations to something around the $280,000 mark instead.
The reason the RBA has been hiking rates is to try to get a hold on inflation, which has been soaring well above its target range recently.
Inflation has meant the cost of living has grown and grown, at the same time as the cost of loan repayments. This has impacted affordability further, because the more money you spend on groceries, petrol and energy, the less you can put towards investing.
Of course, the flipside of inflation is that it boosts the return on your debt.
We have seen rents rising all across Australia as more people try to lease a shrinking pool of available properties. Tenants are desperate for rental supply and are being forced to pay a premium to secure a place to live.
So, if you own one of those places, or are able to get one, you will be experiencing an uptick in rental income, which will boost your yields and help offset the rate rises.
As B.Invested founder Nathan Birch often says, today’s debt will be made irrelevant by tomorrow’s inflation. Because while your debt stays the same or is reduced, the income it earns will continue to increase. Imagine you bought a property for $50,000 in 1990 and only paid interest on it. It would now be worth close to $1 million and you’d still only owe $50,000. That debt is irrelevant and today’s debt will be too in 30 years.
Time to pivot
The great advantage investors have over owner occupiers is that investors don’t need to live in their properties. So if your borrowing power has fallen, you can simply pivot to a more affordable market.
The $400,000 to $280,000 example earlier in the article should not be a problem as there are plenty of properties out there that can be bought for less than $280,000 and rented out for enough to be positively geared.
B.Invested has found a number of properties around that range or even cheaper for clients this year, even in capital cities.
One of the bonuses of targeting the most affordable markets is that the rental yields are often the best. This is because there is always demand for the most affordable places to live (even more so now with super tight vacancy rates just about everywhere).
A $600,000 property might only attract $500 a week in rent, which equals a rental yield of 4.33% and will leave you negatively geared. But if you had three $200,000 properties, each renting for $350 a week, you are getting $1050 a week for the same purchase value as the single $600,000 property. All up, that’s a yield of 9.1%.
So if a reduction in borrowing power pushes you to a cheaper market, it may be a blessing in disguise.