What happens if rates keep rising?

If rates were to continue increasing over the next 5 years to say 7.00%, what typically happens to the property market?

I haven't been investing long enough to experience this so wondering what the experts think?

 

I'm not an expert but will have a crack at this:

Investors go hunting elswhere (shares, index funds, term deposits if rates are good). Foreign investors look to US and UK if Australia is no longer a good deal.
Over-leveraged folks default with a minute rate rise (or so the news claims), more folks default as rates climb higher. PC members with plenty of buffer pick up some new IPs for cheap.

 

depends why they rise.

if it is because inflation ramps up, then typically wage growth also increases. This means that repayments go up in $ terms, but stay roughly equal in value since wages also increase. This is a case of devaluing the currency (ie. more $ required to do the same thing across all aspects of the economy), so the $ value of houses stays the same but true value goes down.

This happens when the government needs to print more money than usual, and signs point to this being part of their current plan. They have high debt/deficit and an ambitious budget that relies on higher inflation than we now have, and they forecast a fall in the value of AUD... both effects of government printing money. This is a "controlled" way of bringing house prices back in line, and likely what the RBA is aiming for with its 3% inflation target. If however inflation goes too high and gets out of hand, it can have disastrous consequences on an economy (eg. Germany in the great depression), so economists are very, very cautious of it. better to drip feed to little than overcook it.

The other scenario of rate rises is what could lead to a recession; that international economic factors push rates up at such a level that the reserve cannot control it. Repayments go beyond what people can afford, so consumer spending falls. this batters retail, and has big impacts on construction. Typically net inward migration also slows, and the result is less money coming in and less existing money circulating. This leads to high loan defaults, and a fall in property prices in both $ and value.

In any case, a major factor is consumer sentiment. If a market is dominated by investors and they see prolonged rate costs impacting their investment, they will likely sell. this brings down house prices but can push up rents, so it closes the yield gap. I am guessing there will be a fair bit of this in Melbourne and Sydney, as 50% of buyers are investors and yields in many areas are absolutely terrible.

 

When I see a reduction in cranes in the sky I don't get concerned about rising interest rates. I had a bank manager tell me the other day that they are trying to lock in clients to fixed term rates by offering better deals to lock in.......No thanks.........
Should federal labor get in with their property policies I cant see a rise in interest rates....More like a retraction due to weaker economic confidence.

 

What happens when I/O rates rise, or even when I/O rates don't rise but do revert to P&I, is that those with weak cash flow and high levels of leverage , who are relying on low rates and endless I/O just to keep their heads above water, start to drown. Forget growth, we have entered a period where simply sustaining what you already have is the prize.

If you consider your resi property portfolio to be a business ( and it is, so you should ) you have now had 2-3 years of warnings that it's costs are facing steep inflation - whether through higher I/O or P&I repayments. , or both. There are simply no excuses for any responsible business owner , having received so many clear warnings, to not be taking steps to improve their business income to counter/prepare for that. Improved income allows for higher costs to be managed, and also for deleveraging to occur, which any sensible business owner knows is an essential part of managing a tighter business environment where costs grow but revenues dont.

The newer your business (portfolio) is, the less time it has had to develop that increased revenue (cash flow) organically through rental inflation. So steps to inject or supercharge the income levels of the business, are now - in my view.... essential to insuring against losing or being forced into selling off your hard earned asset base.

Those businesses which are more mature and have reasonably strong revenues already because they've been held a good while and have time to grow, wont suffer much. But newer business in particular, need to act now. Because before long, even if you do still have borrowing capacity , you may well be facing severe I/O cash out restrictions , 80% LVR's or lower , and tighter I/O servicing . So larger deposits may be required, but will be much harder to extract from your equity.

What Im saying politely is that if you dont take the opportunities available to you now, to add revenue to your business, you may not get the opportunity again.

Don't be under any illusions. The banks have to get their I/O volumes down to 30% of all loans written , and fast. They are currently well above 40% of all loans written as I/O . Getting from over 40% to 30% or less means they need to cull at least 1/4 of their current levels of I/O volume, perhaps quite a bit more. You have already seen more than one rate rise this year out of cycle with the RBA, and now you are starting to see LVR and I/O maximum terms slowly being lowered. These are not the end of the changes. They are the start. The very best case is that only 25% (perhaps more) of the product you and everyone else wants and needs to run their business, is no longer going to be available to everyone who wants it. The worst case is that it will be a much bigger shortage than 25%.

The great news is, if you hold PPOR P&I debt its the best time ever to be borrowing money at killer low rates...but if you are I/O "heavy"... and you arent prepared for P&I , you had best get prepared. There wont be many more warnings.... time is fast running out to get some additional cash flow into your business model so that you can see this period of change out ... remember that these things will pass in time - we wont be in a post APRA tightening cycle forever - but first you have to survive the situation before you can come out the other side and prosper. .

 

7% is the long term trend for variable IR loans. I expect it will get back on trend eventually from these ultra-low rates we've been enjoying for some time now. Same ole same ole.

 

winter is coming

 

Grinds to a halt.
Further; there will always be an element of mortgage stress in this environment, so there will be a few cheaper sales amongst it all.

 

Our primary skill of 'digging dirt out of the ground' is having hard time as it is.
May be the regulators are fearful that our other skill (aka 'flipping houses to each other'), is also at risk due to IO loans?

IO loans has the potential to be our Sub prime if not contained.

 

Just wondering, to de-risk our house of cards, instead of blind rate rises, what about... stop the easy credit to Investors, ie

• Restrict fresh investors loans/refinance to 70/80% lvr
• Remove NG benefits from serviceability calculation
• Calculate serviceability at much higher rate for Investor loans.
• No IO loans till system de-risks itself.
  
  This will potentially end the easy credit to the investors, which will potentially remove the ammo for House price rises.

 

eh? not sure if serious.. this is already what has been gradually happening over the last few months.

 

If interest rates go up there'll be a cataclysmic exodus from property and equities to fixed interest. Cash will flow in from OS seeking returns due the strength of our banking system.

This will cause prices to fall dramatically as no one wants to borrow and cash buyers will come to the fore. There will be a grinding and gnashing of teeth and the earth will open up and swallow the non-capitalists and tenants who can't afford the rent hikes due to the removal of depreciation allowances on P&E where not purchased as new.

Steven Keen will be proved right on his 2011 predictions (even if a little late).

 

when interest rates rise, it equals to a tightening of credit. Less easy credit means less liquidity into the property sector. Property prices should go down countrywide.

However not sure what the recent infrastructure stimulus in the new budget will do, it could very well push up prices as somehow the excess liquidity from the gov into infrastructure could find its way back into property.

We have an interesting situation where the official RBA rate may stay the same or even go down, whilst banks will just raise their rates due to overseas funding rate rises and tighter Apron regulations

 

You are right,
With stagnant pay rise and underemployment being the new normal RBA wont be raising rate in a hurry, But our offshore bank lenders wont have such restrictions.

 

But now with a very high 'debt as a % if Disposable income', not sure if our leveraged Investors would be able to handle an IR rise of even 7%.

From a current rate of 4%, every 1% IR rise results in 25% increase in Interest payment.

Housing Investment is a high leverage bet all good when the price is rising even with rising IR because one can always refinance to afford increased Interest payment.

But when price stalls or falls ... IR hike becomes a challenge like with any other leveraged products.

 

Market sentiment changes, from positive to negative, also lots of negative media reporting. Investors worry about whether they can continue servicing debt, some will sit on their hands, some will try to offload to reduce debt, because they have no choice.

This also means more supply comes to market with this property prices don't continue to rise because we then go from no supply to oversupply

Interest rates have already started rising, just make sure you can service debt as my guess is it will continue to rise.

MTR

 

Take the opportunity of a vacancy to undertake your value-add works to maintain/increase your rent. There aren't too many ways to increase rent and this is a free kick.

 

Well they should be able to as when they were approved for their loans the banks' serviceability calculations were worked out on current IRs + 2-3% (and we are a looooong way from even a 1% increase let alone 2 or 3%).
This is just media noise.
In any event, the end user always pays - I pass costs on to tenants in the form of rent increases.