Is it a good time to buy Australian properties when the interest rate is at an all time high?(well, it came down by 25 basis points last week)
With the federal cash rate at an all time high in 12 years in Australia, investors are questioning if this is an ideal time to enter the property market.
The Reserve Bank of Australia meets on the 1st Wednesday of every month to determine if they should raise or lower the federal cash rate based on inflationary figures as well as the performance of the economy. To keep inflation in check, the RBA will tend to increase interest rate by no more than a quarter percent each time. Banks will follow suit to increase the mortgage lending rates to investors or homeowners that are on standard variable rates. The norm is for bank to increase lending rates in tandem with the increase in interest rates by RBA.
For investors who are looking at entering the market, the high interest rate might not necessarily be a deterrent. The rationale is simple, with exceptionally high inflation due to high oil prices throughout the world, raw material prices have increased. The costs of construction have risen significantly due to those increases in their individual components. It means that the cost of building would have risen as well. The fundamental for real estate is that prices of real estate very seldom go below replacement costs.
What exactly is replacement cost?
It is the cost of land component and the building component combined e.g. if the land costs $400 per sq ft and the building is $350 per sq ft, the basic costs excluding financing and all other costs is $750 per sq ft for the piece of real estate (in this case, an apartment is calculated this way), a selling price of $800 per sq ft can rarely go wrong.
In the current market facing high inflationary pressures, most off-the-plan projects would have the buffer for increase in costs built-in in the prices. It means that if a property is sold to you at $450,000 today for a project that will be completed in 2 years’ time, it means that it is really worth $450,000 in 2 years’ time taking the rise in the built in. It is perfectly all right when you are on the right side of the cycle, meaning on the up trend property cycle. However, things might go pear-shaped if the property market took a turn for the worse come settlement when valuers do a valuation for your property in 2 years’ time.
Things will be different if you are buying a completed property or a property that is under construction with a few more months to settlement. The logic is simple.
When everyone shuns the property market because of high interest rates, they resort to renting. Rental yields in most residential units are 4.5%-5% per annum as compared to current mortgage lending rates of 9.35% (at the point of writing this article), therefore renting is a more viable option than buying a place to stay. The demand for rental properties drove the vacancy rates to an all time low. That doesn’t mean nobody’s buying! It means that people are buying as investment properties but not really for them to live in.
If you can get into the market today, you stand to enjoy high rental yields today. Most of the projects are off the plans and will only be completed in 2010 or 2011, getting into the market today ensures you are not competing with those rental properties when they settle in 2-3 years’ time.
The issue of high inflation will not impact you that much because you have secured a rental property at today’s price and in 2-3 years’ time, should things stay status quo, you can expect your property to rise in value because everything else would have risen. The price that you pay can never be replicated, at least that is the rationale for buying a completed property today.
Ask any seasoned property investors who have accumulated quite a sizeable property portfolio and it is no surprise they are rooting strongly for completed stocks instead of off-the-plan ones.
However, the financial circumstances of individuals are vastly different. The best option is to determine your goals and objectives first before embarking on the journey to financial abundance through property investment.
