Interest rates cuts will ignite residential property market

Cash rates are 4.25% and falling. What’s more, the banks (at least, some of the bigger banks) are putting the reductions through in full. Suddenly the financing of property investment in Australia is on a fresh setting; it’s a once-in-a-generation opportu

Two months ago, when it was neither profitable nor popular, I made a big call live on radio – I said we had seen the bottom of the residential property market.

In the days following I was surprised at the energy some commentators applied to my alleged error. Now with interest rates set lower than almost anyone might have assumed back then, I believe the final elements of that prediction is falling into place.

Cash rates are 4.25% and falling. What’s more, the banks (at least, some of the bigger banks) are putting the reductions through in full. Suddenly the financing of property investment in Australia is on a fresh setting; it’s a once-in-a-generation opportunity and I urge you not to miss it.

The intent of the Reserve Bank and the Rudd Government is quite clear. They have seen the damage done by falling property markets overseas and they are acting decisively to avert the same possibility here. The fundamentals underlying the Australian market are stronger than those in the US, particularly as Australia has high equity levels in the residential market and shortfall of new housing supply.

Even my fellow Eureka Report columnist Gerard Minack, of Morgan Stanley, is now predicting official interest rates will fall to 3% by mid-2009. He’s also suggesting that despite lower rates a sharp fall in the availability of credit will lead to significant declines in residential property prices.

Similarly, Rory Robertson, Macquarie Bank’s interest rate strategist, also believes rates will fall to about 3%. In fact, Robertson has taken the extraordinary step of making a public bet with housing bear Steve Keen, a lecturer at the University of Western Sydney. Keen says Australian capital city house prices will fall – peak to trough – by 40% over the next five years. Robertson says if Keen is even half right (down 20%) he’ll walk from Canberra to the top of Mt Kosciusko; if Keen is wrong he gets to do the walk!

Well, house prices are not going to fall 40%. They’ve bottomed.

As Christopher Joye, chief executive of research group Rismark International, has observed, delinquency rates on Australian mortgages are materially lower than levels experienced in the mid-1990s.

With the sharemarket still looking fragile (if considerably better value) property has been left with the best outlook for any of the asset classes for investors.

Just like the mid-1990s, official interest rates have peaked and are dropping precipitously with mortgage rates falling from about 9.25% to about 6.9% by the start of next month. For a typical investor with a $300,000 mortgage, monthly payments will have fallen by $468 in just three months.

At the same time, the recent stagnation in property prices in major capital cities has seen well-located properties on the market with rental yields as high as 4% to 5%.

Let’s make it clear; yields of 5% and mortgages of less than 7% equals a beautiful set of numbers, a very good prospective market for smart property players. As I said, it’s a once-in-a-generation opportunity to invest.

Many investors will be tempted to ask, “Why move now? Why not sit back, wait and see what the new year brings?” The reason is fairly simple; property, like all other markets, is full of animal spirits and the thin line of investors that had been marching in is now going to swell.

When the fundamentals of property finance change this quickly for home buyers and investors, the result can only be rising demand for property. Clearly, many intending home buyers and astute investors are anticipating the improvement in their funding costs and the broader impact this will have on the market place.

It’s entirely possible that the cumulative effect of the 3% drop in the cash rate in three months will propel a significant number of investors into action over the next few weeks.

Investors who move before mid-2009 will have a real head-start on the rest of the market.

So now that you know how the investment stars are aligning for the property market, many of you will be thinking that as a long as you buy within the next three to six months you can’t make a mistake.

Not true! Just like any other phase of the investment cycle, now is not the time to invest in a property without the solid fundamentals that will see it perform well over time.

If you’re going to invest now, don’t speculate. Start by looking at quality houses and low-rise established apartments in inner urban locations, where there is good access to transport, shops, schools and employment. These properties can always be rented out and will always attract home buyers and investors alike, despite recessions, inflation outbreaks, sharemarket crashes and sub-prime crises. Your equity will continue to grow over time.

The other question that investors will need to ask themselves is whether they plan to finance their investments through a fixed or variable loan. I am no finance expert, but Australia does appear to be entering a period of low interest rates but we’re not quite at the bottom yet. Now is the time to be comparing variable and fixed-rate mortgages and judge just how far fixed rates will come down if the official rate does indeed fall to 3.25% next year.

Now for the wild card; when we look at the combined effect of dramatic interest rate cuts and ridiculously high first home buyer grants, how likely is it that the residential market will experience an unrealistically high spike in the first half of 2009, and how likely is it that it will be sustained?

Could we be in for another period of uncertainty once the grants expire (they must be taken up by 30 June 2009) and once the easing interest rate cycle ends? Perhaps.

However, as long as investors accept that property is unequivocally a long-term journey, taking full advantage of concurrently easy money and rising rents to borrow conservatively on top-notch investments with all the right fundamentals makes very good sense. The prudent investor should budget on reducing interest rates, but factor in the possibility of an increase down the track.

Finally, investors must not squander the additional comfort afforded them by lower interest rates and incur another huge amount of consumer or peripheral debt that is eventually consolidated into their mortgages. If you do, you’re courting disaster with highly volatile credit market and an uncertain outlook for the global economy.

This article first appeared in the Eureka Report