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What will happen if rates go up? In today’s low-interest-rate environment one of the common questions property investors ask is, “What happens if we buy now and interest rates skyrocket, like back in the 1980’s?”
An understandable concern and today’s historically low interest rates can’t be sustained forever because at some point the economy will begin recovering, inflation will grow and rates will rise!
That’s the economy’s cyclical nature for you.
When rates do rise it’s doubtful they’ll hit the dizzying heights of the late 1980s. The major lenders certainly don’t think so; they’re setting their 10year fixed rates about 7per cent.
With vast resources and access to the world’s top economic minds, it’s highly unlikely that major lenders will make the wrong call about the future direction of interest rates.
But for argument’s sake that they do and rates climb back to the heady levels of 20 years ago.
If interest rates go up that far it’s a sign that business and consumer confidence is high. When rates go up so does inflation. And when inflation rises, so do property values. Yes, your holding costs will be higher because of higher interest rates but as an investor you will benefit on three fronts.
High rental returns
First-home buyers won’t be prowling the property market for a buy as it’s less affordable in a high-interest-rate environment. This will keep them in the rental market, put pressure on the available rental accommodation and drive up asking rents. The higher the interest rates the higher the investment yield!
Negative gearing benefits
If your expenditure on the property exceeds your rental income, you’ll be able to soften the impact and increase your cash flow by claiming the difference as a tax deduction.
Substantial sale proceeds
If you can’t afford to hold the property you can sell it. Whilst not an ideal scenario, your property will have grown substantially in value during the time of high inflation so you’ll be better off than when you purchased it and that’s the aim of investing!
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Melbourne’s outer suburb vacancy rates have improved from 0.7 per cent to 1.8 per cent in the past six months, according to the Real Estate Institute of Victoria’s April vacancy rates.
Vacancy rates across Melbourne are reasonably steady having been between one and 1.4 per cent for 12 months. However it‘s significant that there’s a noted improvement in the outer suburbs.
The improvement could be due to the number of first homebuyers moving from rented accommodation into their own homes with the assistance of the grants, bonus and boosts.
The March quarter median prices showed that most of the activity in the marketplace has been in the outer suburbs; for instance Craigieburn, Melton South, Hillside, Epping, Caroline Springs, Werribee and Meadow Heights – all outer suburbs of Melbourne very popular with first homebuyers.
It‘s great news for renters if a by-product of the grants, bonus and boosts is an improvement in availability of rental accommodation, however monitoring of the situation over the next few months will tell of any continual improvement..
We’d consider that the rental market would be in balance once we reach a Melbourne-wide vacancy rate of 3%.
The last month’s REIV members figures have shown a very minor change in the inner suburbs where the vacancy rate moved from 1.5 to 1.3 per cent and in the middle suburbs where it moved from 1.4 to 1.3 per cent.
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Increasing rents boosted the housing component of the Consumer Price Index (CPI) by 0.9 per cent for the quarter and the overall annual increase to 5.5 per cent, that’s according to Australian Bureau of Statistics figures released this week.
The CEO of Real Estate Institute of Australia has said, “The majority of this increase in the housing component was driven by rents, which increased nationally by 1.7 per cent over the quarter and 8.4 per cent over the year. The cities where rents increased the most were Perth and Darwin with annual increases of 10.9 per cent and 13.5 per cent respectively!”
This rent increase in the recent quarter reflects low vacancy rates and the scarcity of rental properties across capital cities, combined with the decrease in building approvals and housing finance for investment.
The National Rental Affordability Scheme should hopefully relieve this figure, however the impact won’t be felt for quite some time.
“With an underlying demand for additional housing at around 200,000 dwellings per year and commencement of new dwellings of 147,000 in 2008, Australia will need to build significantly more houses than what has occurred to meet rental demand.”
Housing affordability improved since the Reserve Bank rate cuts, although there’s really been very little flow-on benefit to those in the rental market.
“With lower interest rates and greater affordability, now would be the time for those within the rental market to seriously consider purchasing their own home.”
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Today’s cut will save a mortgagee with a typical 30-year, $300,000 home loan about $170 in monthly repayments if the lender passes on the full amount. Over the life of the loan, the savings will total about $61,272.
”There was a significant deterioration in world economic conditions late in 2008,” said RBA Governor Glenn Stevens in a statement accompanying the cut. ”The effects on household and business confidence of the financial turmoil following Lehman’s collapse, and continuing strains on major financial institutions, saw a significant downturn in demand around the world.”
The RBA has now lopped four full percentage points off its cash rate since it changed tack and began cutting rates last September. The cash rate has not been this low since 1960, according to Bloomberg data.
The rate reduction comes hours after the Federal Government announced a $42 billion stimulus plan aimed at keeping the economy out of a recession. The spending includes some $12.7 billion in cash payments and $28 billion on new infrastructure projects including roads and schools.
“What they have done is certainly enough, put together with the fiscal package,” said Michael Blythe, chief economist for the Commonwealth Bank. ”Policy setting in Australia is very stimulative, although we are quite likely to see rates lower” in the first half of 2009.”
Double boost
The central bank said it had taken into account the additional government spending.
”The combination of expansionary monetary and fiscal policies now in place will help to cushion the Australian economy from the contractionary forces coming from abroad,” the RBA said in its statement.
Today’s RBA cut matched market expectations.
The Australian dollar initially jumped, rising from 63.5 US cents to 64 US cents after the RBA move. The benchmark ASX200 share index was recently 1.2% up for the day, easing from 1.4% higher shortly before the RBA release.
More cuts to come
The fact the RBA assessed the likely impact of today’s stimulus package indicates the bank may have been considering a bigger cut, said JP Morgan economist Helen Kevans.
Ms Kevan expects another 50 basis point cut when the RBA board next meets in March to complete the central bank’s current easing cycle.
Today’s RBA’s rate cut follows the Federal Government’s revision of growth forecasts for the economy. The Rudd Government expects Australia’s growth to slow to 1% this fiscal year to 0.75% next year - one of the few economies to continue to expand.
The RBA said Australia remains relatively strong.
”Australia’s financial system remains in a strong condition and large interest rate reductions over recent months have been passed through in substantial measure to end borrowers,” the RBA’s Stevens said.
”Nonetheless, the combination of last year’s financial turmoil, a severe global downturn and substantial falls in commodity prices has had a significant dampening effect on confidence, and therefore on prospects for growth in demand.”
The Reserve Bank indicated it had more scope for cutting rates as inflation eases.
”Inflation has begun to moderate and, given recent developments, it is likely to continue to decline,” the RBA’s statement said.
Consumer prices fell by 0.3% in the December quarter, its first reduction since 1997, according to statistics released last week.
Three-year bond futures fell 0.085 points to 97.035, while 10-year bond futures shed 0.045 points to 95.870.
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More than 40,000 unlucky people have been caught out in a fixed mortgage rate trap, having taken out their loan at the highest fixed interest rates in a decade, denied any saving from the recent cuts and confronting costly break fees if they decide to refinance.
Figures from the Bureau of Statistics show 43,632 borrowers signed on to new fixed home loans between March and September, when lending rates were at a decade high. The official cash rate has since fallen by a full 3 percentage points.
According to the research group Infochoice, someone who took out a fixed loan of $500,000 in March would now be paying $800 more a month than if they had opted for a variable rate.
But borrowers looking to refinance face a difficult choice: continue to pay a higher interest rate, or incur thousands of dollars in penalty fees for breaking their fixed contract.
“It’s not just all about the rate,” the head of Infochoice, Shaun Cornelius, said. “There are all sorts of conditions attached to the exit fees. They can be quite expensive.”
While fees vary, borrowers who cancel their loan within the fixed period are typically forced to compensate their lender for the “economic cost” of breaking their contract. This is the difference between the interest the borrower would have paid the lender and the prevailing interest rate. As interest rates fall, this gap is becoming ever wider, meaning it may already be too late for fixed borrowers to save by refinancing.
On top of the economic cost fee, all four major banks also charge an upfront fee, ranging between $300 from ANZ and $900 from NAB, for breaking a fixed loan. Administrative and establishment fees are also charged by the new lender.
Read the full article from Jessica Irvine and Ehssan Veiszadeh of the Sydney Morning Herald here:
http://www.domain.com.au/Public/Article.aspx?id=1228257193360&index=NationalIndex&headline=Fixed-rate%20trap%20snares%2043,000%20home%20owners
Paul Castran
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This week’s interest rate cut is expected to lead to an investor resurgence.
With the arrival of spring, they started emerging from their winter bunkers, scouring every neighbourhood, on the prowl for the easy kill. As December broke and interest rates fell again this week, they became bolder and began pacing, waiting and watching for their weakened prey.
And now, finally, they’ve begun to pounce. “Yes, at last we’re seeing evidence of investors returning to the apartments market,” says John Edwards, managing director of residential property researchers Residex. “There’s real activity now from the investment community and we’re predicting we’ll soon see that translated into a lot more sales.”
The latest rate drop in the cash rate this week, a further 1 percentage point to 4.25 per cent, is expected to further lure the investment hunters. “It will have an effect over time, especially if the rates stay permanently down,” says Australian Property Monitors’ senior economist Liam O’Hara.
It’s amazing to see them stalk in terrain that otherwise looks so parched and barren but the experts are adamant: with falling interest rates, rising rents and the continuing sharemarket volatility, the conditions are perfect for the lean and mean to make an absolute killing.
Read the full article from Susan Wellings of the Sydney Morning Herald here:
http://www.domain.com.au/Public/Article.aspx?id=1228257280539&index=NationalIndex&headline=Back%20on%20the%20prowl
Paul Castran