In order to hold an investment property asset into the long term, a property investor needs to ensure that their weekly cash flow (whether negative gearing, positive gearing or positive cash flow) permits it, because nobody can survive on peanut butter sandwiches and two minute noodles forever.
Over 2015 and 2016, we saw the Reserve Bank of Australia cut interest rates four times, totalling 100 basis points (or one per cent). As a result of this unprecedented low cash rate environment, money has never been so ‘cheap’. In response to this, many lending institutions have tightened credit policy (particularly for residential property) in order to avoid behaviour by investors and developers that is too ‘bull-ish’. This should be welcomed within reason, as it was irresponsible lending that played an instrumental role in the sub-prime mortgage crisis in the United States.
The ‘cheaper access to money’ is beneficial for a budding property investor for obvious reasons, but it is even more beneficial for those wanting to buy their own home for the first time. In an environment where renters become first-time owner occupiers, the rental market will resultantly soften as a simple function of supply and demand. This is one of many elements within the property market cycle of boom, correction, stagnation and upturn.
For a property investor, this has two immediate effects:
• Rental income growth will slow, stop or even decline
• Mortgage payments will be lower than they were in the past
So what is the net result?
The data tells us there is a noticeable relationship between fluctuations in the cash rate and changes in rental yields. Since the property market is traditionally not as open to volatility as a monthly decision on the cash rate, the changes in rental yields take time to respond and are not as extreme.
In fact, over the past decade it appears to take about nine months for the rental market to react to cash rate changes. One reason behind this would be the conditions of typical tenancy agreements which both prohibit landlords from increasing rent over a period and bind tenants to the rental amount for that same period.
To test impacts to the investor in the real world, we conducted an analysis of a hypothetical property investor with a property worth $500,000. If their mortgage rate was 5.5% and their rental income was $500 per week, their net outgoings after tax were $30 per week.
Now with the mortgage rate at 4.5% and all other variables remaining constant, the rent would have to decline by $100 per week (or 20 per cent) for the net outgoings after tax to reach $30 per week again.
From the above case study we learn there are winners and losers of each phase of the property market cycle but it is important to be prepared for each scenario as this is what allows us to hold property into the long term.