Interest Rate is Rising. What does that mean to the savvy investors?

With the RBA coming out and hiking the official cash rate, the tightening cycle is in the full swing and it has left many property investors asking what it all means?

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While paying higher interest is not something any investor wants to do, the situation of higher mortgage rates is not always as bad as some people might have you believe.

The outlook for property prices is also far from set in stone on the back of higher interest rates in the future.

Here are some essential factors property investors should consider.

Interest rates don’t mean price falls.

One of the biggest misconceptions about interest rate rises is that higher rates will hurt price growth or lead to huge falls.

Looking at the recent history of RBA tightening cycles, we can see that property prices had actually increased three of the past four times, 12 months after the end of the rate hiking cycle.

In 2009, house prices were relatively flat after a 1.75 per cent cash rate increase over 13 months. In 2002, house prices finished up 52.2 per cent higher after the cash rate rose 3 per cent in nearly six years.

In 1999, house prices were 15.1 per cent higher after the RBA took the cash rate higher by 1.75 per cent in 10 months. In comparison, the only fall in house prices came back in 1994 when prices dropped just -2.3 per cent after a 2.75 per cent increase over six months.

Overall, we can see that tightening cycles actually haven’t harmed house prices in any meaningful way and in some circumstances, they outperformed.

Interest rate buffers

In recent years one of the significant changes in the way many lenders operate is that they have been required to assess loan applications at a threshold above the lender’s standard rate.

This is called a serviceability buffer, and it’s currently set at 3 per cent above the typical assessment rate. This means that interest rates could rise another 2.75 per cent, and borrowers should still theoretically be able to manage their repayments based on their home loan assessment and income and expenses.

This should ease pressure on many homeowners and mortgage holders and suggest the overall market is not overextended.

Rents are strong.

Rents have been rising across the country over the past 18 months and are up over 10 per cent in the past year. For property investors who earn income from rent, this goes a long way to offset any increase in interest rates.

With vacancy rates at record lows across the country, pressure on rents remains high, and this should help insulate investors from further interest rate pressure.

Equity has been created.

If you’ve owned your property for a few years, there’s a very good chance that you’re already sitting on a decent amount of equity, thanks to the price growth that we’ve experienced in the past 12 months.

As an investor, you could consider releasing some of that equity and putting it aside, typically in an offset account, as a buffer in the event you might need to have some additional cash on hand to manage your mortgage.

Low base

While the RBA has just announced 50 basis point increase, we still need to remember that the overall level of interest rates is coming off an incredibly low base. In years gone by, many mortgage holders were paying 7-10 per cent mortgage rates and far higher than that back in the 70s and 80s.

Given the low base that rates are coming off, we have to remember that rates are really just normalising rather than increasing. The RBA made it clear that when rates got slashed to 0.10 per cent in early 2020, it was a short term phenomenon. Higher rates have been on the table the whole time; the RBA has simply bought forward their tightening cycle.

The economy has bounced back.

After what has been a rough few years for the economy’s health, the RBA has decided to start tightening its monetary policy at a time when things have recovered.

While inflation is high, unemployment is at record low levels, and many businesses and industries have been booming thanks to the low-interest-rate environment. Interest rates at virtually zero are not a sign of a healthy economy, and the RBA believes the economy can withstand rates at a more normal level.

We’re also seeing the return of immigration and international students, which we haven’t had for many years. This has traditionally been one of the big drivers of house price growth and rental growth, as new immigrants often rent before buying.

Clearly, there’s still a lot to be positive about when it comes to investing in property. Moreover, as interest rates rise, it will spook some speculators and force them to sell, and as a result, some markets might start favouring buyers. This is precisely when savvy investors should be looking for and identifying considerably undervalued properties.

As the property market switches to being more of a buyer’s market, it is perhaps one of the best times to gain exposure to the right property at the right price.

In the words of Warren Buffett, “Be fearful when others are greedy. Be greedy when others are fearful.”

Next steps: Should you want to learn how the author built his $5m balanced portfolio in 7 years and aspire to own something similar, feel free to get in touch via email at rasti@getrare.com.au or book an appointment here.

Disclaimer: This article is general in nature and does not take into account your situation. You should consider whether the information is appropriate to your needs, and where applicable, seek professional advice from a financial adviser.