A virtuous combo of low interest rates and a tight rental market is sparking renewed interest in residential property among investors.
Interest rates have now fallen to such low levels that, for the first time in years, astute buyers are able to find a selection of “positively geared” (or “positive cash flow”) investment properties:
that is, dwellings where the rental income is greater than the mortgage repayments and other costs associated with owning the property.
This is in sharp contrast to the housing boom of recent times, when investors were willing to buy a property with rental income that was not sufficient to cover all their costs. That means they were negatively geared in the expectation of eventually making a healthy capital gain. In addition, they could generally expect tax benefits from their ongoing losses. However, experts warn these circumstances may not last. In particular, interest rates could eventually start heading back up again, while continuing rises in unemployment and other factors may place downward pressure on rent levels.
Steve McKnight, the founder of the PropertyInvesting.com website and author of From Zero To 130 Properties In 3.5 Years believes now is the right time to be taking advantage of the market and thinking about positive cash flow. “When I started buying in 1999 you could find positive cash flow properties but you were pretty much restricted to outer areas and regional areas,” he says. “But with interest rates coming down so far, positive cash flow properties are starting to crop up in metropolitan areas.”
For buyers who plan to borrow about 80 per cent of the value of a property, he uses what he calls “the 1 per cent rule” as a quick means to judge whether the investment will be cash flow positive. “Find out what interest rate you can borrow at, which is a reasonably easy task, and then you add 1 per cent to it,” he says. “All your costs are covered by that 1 per cent. So if you borrow at 5 per cent, then add 1 per cent and that 6 per cent becomes the minimum return you require on your investment.” But Rory McLeod, the national director of research at Colliers International, issues a warning: “There is a slight trap there, which is that interest rates are at historical lows and therefore the upside risks are quite pronounced,” he says. “In a year or two we can imagine that interest rates will have stopped falling. “Then, with all the stimulus packages and the borrowings from the Government we could possibly see a resurgence in inflation during the recovery phase. That will lead the Government to raise interest rates, which will put pressure on home buyers. If they are currently paying 5 per cent and the rate rises to an historically more normal 7.5per cent, that is a 50 per cent increase.” He also cautions against expecting rents to continue rising. “We may have hit a ceiling in rental affordability,” McLeod says. “I have a number of bits of anecdotal evidence that say people are handing back their keys and moving back in with their parents. Things like that.
“They just cannot afford to continue to pay escalating rentals. It is very difficult to quantify but I think we are going to see lifestyle changes, because people find housing is unaffordable. “Most renters are in their 20s. So they go back to mum and dad and try to save up for a deposit. “Or, alternatively, they start living more densely. Instead of having only two people in a two-bedroom apartment you might end up getting a couple and a single moving in – something like that.”
Unemployment is the other issue that has the potential to upset all predictions. Few doubt it will continue to rise. “The issue of unemployment is certainly the wild card, there is no question about it,” says Monique Sasson Wakelin, director at Wakelin Property Advisory. Consequently, she does not expect rents to rise much further. “The expectation of rents continuing to rise stratospherically is unrealistic,” she says. “But I do not see them falling. I expect them to remain fairly firm.” Like many experts, she points to a looming housing shortage as the main contributing factor. This is highlighted in the March edition of ANZ Property Outlook. The report says: “Underlying housing demand is running at just over 180,000 per annum, while new housing supply is shrinking rapidly.
“Building approvals have collapsed in the past year and completions in 2009-10 could fall below 120,000. Australia currently has one of the (if not the) strongest population growth rates in the developed world and even if skilled migration targets were cut to zero in the years ahead in response to fears of rising unemployment, underlying housing demand would still be 150,000 in 2010.
Source: Sydney Morning Herald. (26 April 2009)