Interest Rates Rise & Cash Flow

Discussion in 'Investment Strategy' started by Realist35, 23rd Jan, 2017.

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  1. Realist35

    Realist35 Well-Known Member

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    Hi guys,

    Just recently watched a property couch podcast where they mentioned how interest rate of 7% should be used in all of our cashflow projections. This is quite different to the 4.5% figure I have been using.

    With 4.5% figure in mind, I calculated that I can comfortably afford to hold 4-5 properties on an average income (not buy, just hold). However at the interest rate of around 7%, I would be struggling to hold two properties.

    I suppose that with interest rate rises, rents normally increase as well which can mitigate the rate rises? Do the rent rises completely cover the increase in the costs due to the increase in interest rates?

    Cheers!
     
  2. mikey7

    mikey7 Well-Known Member

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    Dependant on your yield, you'd pretty much have to double your rent to cover the interest.
    I highly doubt you'll be able to double rent.
     
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  3. D.T.

    D.T. Specialist Property Manager Business Member

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    Remember rent dollars (and also sale dollars) are a function of supply / demand on the market, eg how many properties are available vs how many people are looking.

    They are not a function of, nor related to, what your expenses are.
     
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  4. Realist35

    Realist35 Well-Known Member

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    I understand that with interest rate rises, less people can afford to buy and hence more people will be renting. Hence this pushes rents up.

    What interest rate would be sensible to use for cash flow projections (to ensure I can afford to hold the properties?

    For example, I might be able to hold 5 properties at 5% interest rate, but only 3 properties at 7%, meaning I might have to sell 2. Not ideal.
     
  5. CK_Invest

    CK_Invest Well-Known Member

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    4.5% is not too far from market rates right now, it just takes one or two rate RBA hikes or further push by the banks independently (eg citing funding costs / capital requirements etc...)

    will your income substantially increase when that happens?
     
  6. The Y-man

    The Y-man Moderator Staff Member

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    @Realist35

    I agree that rent (while not related directly to expenses) is related to the wider issues of supply demand as you say.

    Depending on how far out your projections are, how about using the long term fixed interest rates offered by banks?

    eg
    Fixed interest rates | Westpac

    So if people's arguments are correct in that banks always win with fixed rates, we could assume these are "worst case" in normal circumstances, unless say Trump get elected.... uh hang on, forget that....

    The Y-man
     
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  7. Realist35

    Realist35 Well-Known Member

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    So in summary, you believe property couch guys made a good point when talking about 7% rate as the baseline for the future holding costs?

    As said above, rents will rise as well, I'm just not sure how much will this mitigate the interest rate rise..
     
  8. MTR

    MTR Material Girl Premium Member

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    Its all about supply vs demand, at the moment in Perth we have an oversupply of properties, people who can not sell their properties due to downturn will automatically place them on the market to rent, so we have an oversupply of rentals and properties on the market.
     
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  9. MTR

    MTR Material Girl Premium Member

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    As interest rate rise this will also impact on your capacity to service debt with banks, it could even be less in terms of the number of properties you can buy.

    Also, when interest rates start rising this is can also be a trigger for property prices to correct, no loans no houses. Not to mention market sentiment changes.
     
  10. The Y-man

    The Y-man Moderator Staff Member

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    I'd say 7% for a 10 year projection, but 5% for a 5 year projection.
    I don't factor in rent rises in my projections incidentally.

    The Y-man
     
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  11. MTR

    MTR Material Girl Premium Member

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    Could also do a mix and lock in rates???
     
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  12. The Y-man

    The Y-man Moderator Staff Member

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    I find the other thing about projections, forecasts and risks is this: The banks are more risk averse than me! (by a long shot).

    So even if I think I can hold 4~5 IPs, a bank is likely to tell me 2 or 3 which is fine. I have effectively used their risk management department for my own good (uh, I hope they pay their risk management people well....).

    I wouldn't get too bogged down with analysis paralysis. While planning is great, you can't cater for every single factor.

    The Y-man
     
  13. skater

    skater Capitalist -- www.skatepro.com.au Premium Member

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    You have to realise that we have the lowest interest rates that we've ever had. They won't stay this low forever. IMHO, if you can't afford for rates to go to 7%, you can't afford to hold that much property.

    Rates WILL go up. How far? No idea. When will it happen? Don't know that either.

    Relying on the rents to rise to cover it is a flawed strategy. Rents will, of course, rise, but as that is governed by supply & demand, there is no way to account for when or how much they will rise by, or if they will rise enough to cover the interest rate rises. You may only have small borrowings, and be completely covered, or you might have a huge debt, that a few $$ in rent increases won't even make a dent in the repayments.
     
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  14. Kangabanga

    Kangabanga Well-Known Member

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    To be prudent u should factor in a possible scenario of 7% rates, Property price correction 20-30% and loss of rent. That's when the banks come knocking on your door.

    Our rates are mainly based on overseas funded rates, thats why bank rates have been moving up in tandem with american rates rather than staying in tandem with RBAs rates..
     
  15. CK_Invest

    CK_Invest Well-Known Member

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    i believe 7% is good to be on the safe side, borrowing to the hilt and being able to survive at rates of 4.5% is a recipe for disaster in my opinion, why do you think the banks now are primarily using 7%+ for your servicability? they have thousands of staff who are just as concerned with housing / lending as you are.

    I don't know what rates you're on now but taking 4% as a typical market rate, are you saying you can only handle 2 rate rises from the RBA with your current portfolio without having to sell?

    combine that with a challenging funding market (yes even trump / the fed can have an indirect influence on your mortgage rate just look at the 10 year us treasury yields +60bps post trump and the recent fixed rate rises), I think a 50bps rise within the next two years is not an impossibility

    also i dont know where your property portfolio is located; but it is definitely a supply vs demand thing - you can try to pass on your rate hikes to your tenants but how easy would that be given all the apartment supply in major cities now?
     
  16. dabbler

    dabbler Well-Known Member

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    The banks are supposed to be calculating with 7% rates in mind & what you say are your living expenses.

    So in theory, you should not be able to buy more than you can hold at 7%
     
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  17. KayTea

    KayTea Well-Known Member

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    That's what I thought, too. A couple of recent interactions with brokers had them calculating affordability at 7.2% (from memory..... could be +/- 0.2%).
     
  18. fols

    fols Well-Known Member

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    One should absolutely be conducting this exercise. 7% is more or less the long term IR average. Current rates are best on record and can't last forever.

    Need to have a mitigation plan. I've fixed about half my debt for 5 years and can weather moves on the variable portion, which at $3m is still sizeable.

    Even my plan isn't foolproof, as I need to consider what happens at end of 5 years- not only move to the variable rate, but also a potential move to P&I.

    Sure rents move up over time, but so
    do rates, insurance , strata and utilities. This won't be your saviour.

    That's why debt reduction is so important. This is a key focus for me.
     
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  19. MTR

    MTR Material Girl Premium Member

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    interest rates have already gone up
     
  20. C-mac

    C-mac Well-Known Member

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    ^^^^^ This.

    Inflation can be a bitch. Even in a time of technical STAGflation in Australia right now, ain't it funny how council rates, water costs, tradies, and other property holding costs still manage to bump up their rates in line with CPI 'INflation' rates, even though we are in stagflation all things considered.

    So, dont rely on what might be a nominal rental increase rate across your portfolio of say 5-10%, to offset the holding costs of 7% interest rates (which is about 30% higher interest actually paid). 10% increase in revenue minus 30% increase in holding costs is a net position of being BEHIND by around 20% or so!

    For this reason always have some cash cash cash stores tucked away in offsets for a rainy day (or indeed, a rainy 'year' if you will).