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Are interest rate rises killing off investors?

As rates increase, we all hear stories of higher mortgage payments and broken budgets, but are the recent adjustments in interest rates enough to kill off property investors?

The short answer is no – in fact, it’s quite the opposite.


Whilst there is no shortage of doom and gloom reporting when it comes to the property market, savvy investors are seizing the opportunity to jump into a market with rising rental yields, underpinned predominantly by a severe lack of supply and increased demand from migration. Add to that, a growing list of buyers who’ve delayed their decision to purchase a home or investment property through a lack of short-term confidence – and you’ve got an undercurrent of demand that is likely to lead us into our next property boom within the next 12 – 18 months.

The table below shows the increasing rental yields (rental income) across the various capital cities. Currently, six of our eight capital cities are well and truly above 10% p.a. increases, with Sydney, Melbourne, and Brisbane all above 15% p.a.

Capital City Rental Yield Changes (Dec 2021 – Dec 2022)

Capital City Yield – 12-month change (%)
Sydney 21.3%
Melbourne16.5%
Brisbane18.3%
Perth15.2%
Canberra2.6%
Adelaide13.0%
Hobart4.6%
Darwin14.3%


We’re in need of another 150,000+ dwellings

Last year, we published an article titled, ‘Hey Australia we need to talk… we’ve got a supply problem,’ where we detailed Australia heading towards a “housing supply crunch” that was going to leave us with a dwelling shortage of approximately 163,400 by 2032. This shortfall will be driven by an average deficit of 20,000 homes per year until 2032, estimated by The National Housing & Finance Investment Corporation.

What we discussed in this article is currently playing out as we speak, with pressures from migration and construction delays widening the gap between the new property supply we need and the properties we’re building.

International migration was always going to be a key part of Australia’s recovery from severe labor shortage post COVID-19.  The influx of overseas visitors coupled with a property supply shortage has created the perfect rental storm resulting in skyrocketing rents.

Whilst the practice of rental auctions has been outlawed in most states, many potential renters are being encouraged to make offers above the asking price to increase their chances of securing a suitable property. This is not a situation that is likely to resolve itself quickly, as the property supply tap cannot simply be turned on and off in a 12-month timeframe.

This supply shortfall puts a significant strain on rental markets around the country and is the major factor in driving rents upwards – not great for those looking for a rental property but great news for current and future landlords.

With interest rates now close to 6%, what does this actually mean for investors?

What does the combination of rising rates, crippling undersupply, and climbing rents actually mean for property investors? During times like these there is a real opportunity for investors to take advantage of the current market sentiment, as A+ owner occupier properties become easier to secure.

A good example is a boutique housing sub-division that we currently have access to and recommend, in one of Brisbane’s most highly sought-after bayside locations, offering 4-bedroom house options on 400sqm of land, neighboring one of QLD’s top private schools. If we rewind 12 – 18 months, the 45 lots here would have been snapped up quickly by the feverish local market. At that time, our relationship with the developer would likely have allowed us access to 1-2 properties. But, in the current environment, a slight slow-down in activity has enabled us to access 5-6 of these homes for our clients which means that we can get more investors into the properties that we recommend and our clients are still buying into a development where 80-85% of homes will be purchased by owner occupiers.

Can investors afford to hold an investment property with rising interest rates?

The initial thought might be that with rates tripling over the last 18 months, purchasing an investment property might not be the smartest move from a cash flow perspective. However, when we take a closer look and compare the holding costs of an investment property 12 months ago versus now, that’s not entirely the case.

The table below shows the holding costs for an $800,000 Sunshine Coast townhouse, both today and 12 months earlier.

Both scenarios below have assumed the following:

  • A couple investing $113,000 (10% deposit plus costs) on an $800,000 purchase
  • Borrowing 90% with $19,000 lenders mortgage insurance
  • A combined income of $180,000 (34% tax rate)

Scenario AScenario B
$800,000$800,000
$670 per week rent$775 per week rent
3% interest rate (interest only)6% interest rate (interest only)

Scenario A Scenario B
Annual before tax holding cost$4,375-$13,166
Annual after tax holding cost$10,705-$560
Weekly after tax outflow/inflow$205 per week-$10 per week

The numbers illustrate that it is still possible to hold the $800,000 asset for just $10 per week after tax. For an investor at a 45% marginal tax rate, the after-tax cash flow is actually $3,129 positive per year.

Conclusion

Whilst many economists and the RBA are predicting another 1-2 rates rises in the near future, the above illustrates that holding costs for an investment property are still very much in line with the long-term average and affordable to the average investor.

As always, the Binnari team is happy to share further insights/research with our investors and partners, so please feel free to reach out if you have any further questions.