Things would be easy if everyone could create their own full-proof investment strategies overnight. However, choosing an investment strategy that aligns with an investor’s personal and financial goals would be worthwhile, given that each strategy has its own intended and unintended risks. These strategies can become guidelines and a possible reminder to investors on how to conduct and manage their investments. Investors must also make their analysis of a property’s viability and determine if they are able to commit to the investment.
Selecting an investment strategy shall depend on the present state of the economy. The existing economic conditions can positively or negatively affect the return of investment hereafter. The nature of the market is unpredictable, and investors can attempt to read the foreseeable prospect for the market. There can be unprecedented inflation or deflation of prices, scarce skilled labour, fiercer competitors, and the like.
The real estate industry also experiences economic expansion and contraction contingent on the local, national or international domain. Nonetheless, the property development market provides high rewards in the long run since property continually appreciates. Property value can be translated into future cash flow, and there are various components related to real estate investments. One of these components is the interest rates of loans that investors always consider, especially those determined to own properties for investment.
How to Stress Test Your Property with Interest Rate Increase
VIDEO TRANSCRIPTION:
Once logged in on the main dashboard, click Tools and select Investment Property Cashflow Calculator.
You’ll be presented with 5 different property columns, where each column represents a different property. All fields have been pre-populated to help you get started. All non-gray fields or boxes are user editable.
You can change the values of Property Price, 10 Yr. Avg. Annual Capital Growth, Vacancy Rate, Deposit, Rent Per Week, Values under Recurring Costs and all the non-gray fields.
The Gray fields are non-editable as it has formulas on them.
The Stamp Duty is automatically calculated based on the state you selected.
You want to see how different interest rate increase will affect the cashflow of your existing property or the property you are buying.
As an example, on Property 1 let’s change the property price to $500k thousand, the Rent to $400 per week, and let’s leave the Deposit to 20%. Since the property is a house let’s put zero or nill on Strata.
Next, in the bottom of Property Column 1, click the “Copy inputs to Property 2 to 5” to copy all the values of Property 1 to Property 2, 3, 4, and 5.
All Property Columns now have the same exact values.
Next, change the Interest from Loan for each Property Column.
Let’s start from 3%, to 3.25%, and 3.5%, then 3.75%, and lastly 4%.
Looking at the Cashflow Before Tax section, where Green means Positive Cashflow and where Red means Negative Cashflow, it’s showing how much impact a change on interest rate will bring to your investment property’s estimated cashflow.
Our example shows that the property will be negative cashflow when the interest rate increases to 4%.
You can save it as a pdf for your reference or present it to a professional consultant such as your financial planner or accountant.
If you are a buyers’ agent you can use this and present it to your client or if you are a real estate selling agent you can use this to win a potential vendor.
Crunching numbers and stress testing a property with interest rate increase made fun quick and easy with SuburbsFinder’s Cashflow Feasibility Tool!
Interest Rates for Economic Recovery
The coronavirus pandemic created various conditions to the standard way of living. Countries underwent lockdown to the point that there was a hefty decline in global economic activity. Central banks undertook precautionary measures to mitigate and modify economic deterioration and support recovery by stimulating economic activities. Interest rates, especially mortgage rates, were reduced to an all-time low. This gave the real estate industry and its market the potential to thrive in the competition of having lowered mortgage rates.
However, everyone and everything started to adapt to the pandemic. Business resiliency helped upturn the economy again, albeit slowly, but inflation is picking up quickly. The Reserve Bank of Australia (RBA) has started withdrawing a portion of the extraordinary financial support established to aid the Australian economy amidst the pandemic. Interest rates have surged once more, and the Australia mortgage rate* in April 2022 is at 4.34% compared to the 3.77% in March 2022.
Inflation in the market has surged at the start of the 2022 to 5.1%, from 3.5% in Q4 of 2021. As expected, inflation surged due to global factors. There were supply disruptions and shortages reflecting higher fuel prices and building costs. A further rise in inflation is expected and RBA is intending to raise interest rates further to stabilize the economy, lowering the frequency of recurring and prospective clients acquiring loans, thus curbing inflation. This potential situation affects investors and even homeowners who wish to invest by applying for loans from banks. There is a need to strategize and allocate an investment budget for the onset of alterations in the interest rates.
*The Australia mortgage rate refers to the 3-year bank lending rate on home loans
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Property Market in Times of Hiking Interest Rates
The real estate industry has a dynamic free market which means that the pricing system is regulated by buyers and sellers; however, the market is susceptible to rapid changes in the business environment. One factor that can influence the dynamic free market is a rise in interest rates.
Situational Example:
You found the perfect house to buy and invest in, costing $1,100,000. Most Australian bank loans have a Loan-to-Valuation Ratio (LVR) between 60% to 80%. Assuming the loan is at an 80% LVR, the loan for the house shall be $880,000.
Option 1 (4% Interest Rate):
You want to avail for a 30-year fixed mortgage with an interest rate of 4% and make twelve payments a year (one payment per month). Each month you will have to pay $4,240.
Option 2 (5% Interest Rate):
You want to avail for a 30-year fixed mortgage with an interest rate of 5% and make twelve payments a year (one payment per month). Each month you will have to pay $4,725.
Higher interest rates eventually lead to higher loan costs. Interest rates and loan charges are also influenced by personal factors, which means that the rate is determined by the income and credit income of the buyer, as well as the size and type of loan to be applied for. Costly mortgage loans lower the frequency of buyers to avail them. Because of this, the demand for purchasing is lessened. Subsequently, home and property sellers will have to lower their prices to attract buyers.
The real estate investing market benefits from an increased mortgage loan and interest rate since rental properties increase. Rising interest rates essentially reduce prices which proves to be beneficial if one is to buy during this transitional time. Real estate investors consider the rise of rates as an unexpected gain since the demand for rental properties increases while the demand for new housing declines. With tighter lending standards and higher rates, more people will need to rent until they can afford a mortgage.
Interest Rate Changes in the Real Estate Market Forecast
Interest rates typically escalate during an economic expansion, and various assets react correspondingly. Adjustments to the interest rate translate to reassessing the real estate market and investments. The rising-rate environment has a positive effect on income-generating real estate property. The first influential factor in property investment value is the buyer’s capacity to purchase residential properties. The second influential factor shall be the current mortgage rate.
In the Australian housing finance forecast analysis for March 2022, there were new loan commitments to two types of clients: owner-occupiers and investors. Loan commitments include residential land purchases, dwellings, and any modifications and/or additions. Investors are consistent in their loan commitments for the past year; however, it does not apply to owner-occupiers. Owner-occupiers have been slowly applying for loans for the past month, but there were considerably fewer owner-occupiers that applied for loans in 2021. The current trends for housing property owners were to purchase existing dwellings and purchase newly erected dwellings.
There are events of property appreciation to follow the pace of high inflation; however, procurement of new property slows down. With this, occupancy rates and rental prices spike up. In times of high inflation, buyers are in a tight spot since they have to pay more, while investors benefit if they sell their properties or simply raise rents. There may be just some additional factors to consider as to where they will put their proceeds next.
