The impact of increasing interest rates on property prices

Correct

$1Million @ 4.25% IO = $42,500 per annum
$1Million @ 4.25% P&I with 30 year term = $59,040 per annum
$1Million @ 4.25% P&I with 25 remaining years = $65,016

As ugly as it may be for investors to find and fund an additional $16,540 - $23,516 per $1Million of debt in this hypothetical - none of which will be deductible by the way, as its P not I , meaning thats 16-23K per annum NOT being paid off O/Occ debt because its servicing INV debt ...it gets uglier under some scenarios.
Consider this; assessment rate is moving up too. HEMS will increase significantly as well. So for investors who cant secure a new IO term or even a new 30 year P&I term, holding costs represent significant risk. For some, it will reintroduce the P&I cliff that was deferred in 2020. For all, it will create holding cost issues/challenges.
For those forced to migrate to P&I with 25 remaining years , a further 25bpts would see this increase to 4.5% P&I and $66,708 per annum. That's an additional $24,208 of non deductible principle to fund annually
A further 25bpts would see this increase to 4.75% P&I and $68,428 per annum, which is an additional $25,928 of non deductible principle to fund annually
A further 25bpts would see this increase to 5.00% P&I and $70,152 per annum, which is an additional $27,652 of non deductible principle to fund annually

If rates go up by something in the vicinity of 2% as some are predicting and borrowers are paying rates closer to 6% P&I , that will mean annual repayments of $77,328 which is a gap of $34828 from the $42,500 they had been paying in this hypothetical

In a hypothetical such as this, how many investors with vanilla yields who avoided the first P&I cliff because of rate cuts and reduced assessment rates would be fortunate enough to do so when their IO terms revert this time?

Told you it was a sugar hit.
Told you it would run out of steam by early/mid 2022.
Told you the P&I cliff had been deferred not resolved
Told you cash flow and debt reduction remained the key to HOLDING and that it should continue to be a strategic part of a portfolio.


Will any of this happen? Will rates go up by 200bpts ? I am not convinced yet. I still feel the inflation is being imported and is not being created by domestic issues. At a very simplistic level, will a higher cash rate cause lower shipping prices? Will the price of timber or steel or cars come down ? No. Prices are rising because of external factors, not domestic factors,so I don't see the text book approach being relevantor effective in this set of circumstances. If they pursue the text book approach too aggressively; if they go too hard too fast I fear it could cause many to batten down the hatches, stop discretionary spending and send small businesses to the wall- this time without any covid support payments... leading to ugly ugly unemployment levels and a hard recession - and that's why I am not convinced the RBA will go hard or fast .... but in the end, who knows?

What I am far more confident about is the fact that ( for investors anyway) cash flow remains king , and paying down debt is smart , whether asset prices are going North, South, East or West ....

.

 

In order for the prices of steel and timber or cars to go higher, customers had to accept those price increases. Customers had to be willing to pay more. And they are willing to pay more because interest rates have been at record lows for the last 2 years.

Once people have less discretionary income, they are not going to be willing to pay 10% extra every year for their home construction costs or for a new car. They will defer spending instead or choose lower priced options, forcing sellers to lower prices or at least stop increasing at the same rates they have been.

Are you suggesting it's a coincidence that recent high inflation which is 'caused by external factors' just happened to start after 2 full years of emergency level record low interest rates?

 

In a heavily globalized world like we are in right now, Inflation, imported it may be, is still quite relevant part of the equation. Deglobalization on other hand will come with its own inflationary cost.

May be... just may be... kicking the debt can further and further, as a preferred policy tool, may have its limit.

 

If you think that the current inflation on building materials, energy, commodities and asia-manufactured goods is caused by supply side issues including war and logistics issues due to covid, yes.

Looking at it another way, if an increase in demand can be absorbed by an increase in supply, then prices stay the same.

 

In monetary school of economics, they teach that inflation is created by governments (central banks). They control money supply, and generally do it in a band that matches with activity. This is not what happened over the last two years. Money supply exploded, activity fell or didn’t rise correspondingly (covid). To allow adjustments to occur without recessions governments set inflation a bit above 0.

IMO this inflation problem, globally, is a function of using a fiscal and monetary bazooka to a problem that a pistol/shotgun would’ve solved. That is, at the time, we had very very little idea how the economy would function during covid. In times of extreme uncertainty, the policy response was to go very big. Very very big. It was the right call with the information on hand then. On this very forum a few days before JobKeeper announcement I was befuddled with the small size of the response. They then went with the biggest scheme ever, and then did more and more.

Unwinding this has been slower than required by governments around the world and the ensuing consequence is a global inflation problem.

If activity has exploded and supply hasn’t matched it - we label this as a supply side crisis. I don’t agree. If activity levels are elevated that’s a demand issue. Supply can’t respond to increased demand sure, that’s how inflation always comes about (housing market is a great example of this). If activity hasn’t actually increased and supply levels have fallen (eg a cyclone hitting agriculture) that’s a supply side issue. Oil is a supply side issue, supply levels have crashed given war. Other items that haven’t been able to explode production beyond normal levels, that’s demand pressure related.

As an aside, I’ve been lucky enough to train under some of the shadow RBA board and talk at length with some brilliant monetary minds in the country, many would agree (and disagree too, this is highly debated amongst economists). The RBA and most central banks appear to be in this inflation fighting camp using the main tool they have.

The point is, reducing the money supply should be fairly effective in getting core inflation back down over time. More effective in Australia given high debt balances.

Ideally the Federal government actually come up with the right macro settings to match the realities of the world. It’s no longer the time to run stimulatory fiscal policies, this may be required pretty soon though if the RBA pushes cash rates to 2.5%.

 

Not a chance it has hit a limit.
They still haven't gone down the negative interest rates and digital currency.
Plenty of innovative ways to skin a cat.

 

super interesting thread - just wanted to say thanks for all opinions

 

I'm not suggesting anything other than this; shipping cost inflation started over 12 months ago and while we are being told it is being caused by a shortage of shipping capacity I have been told by people who ought to know that it isn't necessarily so. I have a lot of clients who work for large global transport companies who tell me that the industry "word" is that this is a deliberately engineered shortage, specifically designed to create inflation across western economies now laden with debt. ie that over a third of the worlds shipping container capacity has been removed from the water in order to create bottlenecks and drive up costs. Whether its true or not I cant say, but if it is, no amount of RBA activity will stop the high shipping costs nor the associated inflation. Given the senior roles many of these clients have in global transport/logistics companies, I have to accept the probability of what they are suggesting is high. After all, they really ought to know , right? That is why I am at least somewhat sceptical about whether or not the text book approach ( pumping a series of fast rate increases into the place) will be either effective or even pursued.

 

You’re correct in that it is artificially manufactured by companies but it is in part caused by excess moneys in the system. As items increase in price people will choose not to pay high shipping costs and go without, shipping companies will then reduce prices to draw consumers back in. It’s All cyclical....

 

Sorry but I’d disagree with most of these conspiracy theories about inflation.

Firstly, if the aim was really to increase Inflation to get debt levels under control, they are on track to fail in that task dismally. While inflation is up, it’s going up to such an extend that central banks around the world are having to slam the breaks on. The rapid slowing of economic growth is only likely to spike debt levels, at least at the govt levels.

Secondly, it’s not really hard is it to see the many reasons why shortages are appearing and prices spiking, that have nothing to do with shipping costs. Economies aren’t made to be shut down and restarted like they have been, let alone at different stages in what is obviously a very interconnected global economy. Production shutdowns, and handouts to households, were always possibly going to create big problems and they have. Not rocket science, and don’t need to reach for the conspiracy theories to get there.

 

It’s not a conspiracy theory. When liquidity is added to any financial system prices will increase. Globally we added around 20% more currency into circulation over the last two years, prices will naturally increase.

Now we have begun the tightening process, prices will naturally decrease as money flows out of the system.

 

I meant the idea that shipping capacity has been deliberately held back to drive inflation.

 

Ever heard of geopolitics ?

 

Ya need both.... lots of people have bought just on CF on lower socio areas.. some have not exited out of primed markets like Hobart/Sydney...lets see...

 

Ya had me at hello....

But the vegan vampires are telling me that there is not such thing as an IO cliff....it is simply a figment of my imagination. Even if that happens...rents will increase possibly by 30%. Do ya believe in tooth fairies...or vegan vampires?

On a serious note a lot of younger investors have never seen an interest rate increase in 12 year..add to that IO going to PI...it will get interesting....

 

Shipping costs have increased, most likely due to fuel prices and higher running costs. As for the shortages, I'd say you're spot on. There's a big shortage of materials worldwide and the industries that can afford to buy the stock are at the upper end of the market, say for e.g. the mountain bike industry would have lost some material supply to the car industry as they would pay more for the material and the end user would more likely pay for the increase.

 

Shipping isn’t really held back in any major ways. If you want a container you can easily get one shipped, just need to pay more.

 

Significantly more. 5 x more. 6 x more. 7 x more. The question is; why has the cost risen so much? The "conspiracy" - if thats the right term, is that it's being caused not simply by increased demand, but also by @30% of containers being removed from action. Of course increased demand will be a factor, but is is enough to drive 5,6, 7 x price rises? As I said in an earlier post, people I know - people who ought to know - tell me they believe it's being manipulated quite deliberately. I do not know whether they are correct. I only know that IF they are, the RBA's efforts to quell inflation will be largely wasted. Price rises will continue to reflect shipping costs. That being said, I DO believe they need to move the cash rate up in order to have some contingency restored for the future. In my mind at least, a relatively quick 1% increase over 12 months would be welcome. 2% or 3% would not .

 

Long term that's the trend and particularly Sydney more than Melbourne. But odd factors like COVID would change that somehow for a period of time, eg., booms in regionals. But if you have money to bet, I would put it in Sydney, a house with good land component and as close to CBD as I can afford. Of course just this criterion will filter out many.

 

I think people are under

to me the 1 and only 'odd factor' is QE = zero interest rates + liquidity etc .. as rates continue to go up and we move into QT, the 'odd factor' will disappear