Rising rates offer an opportunity

Cool headed investors should be preparing for an era of higher interest rates by securing good growth assets.

Most investors will be keeping an eye on any Reserve Bank moves to raise interest rates over the next few months. At the same time, they should be aware that some of the big banks are looking at increasing their lending costs to offset margins lost through borrowings on global wholesale financial markets in the wake of the United States sub-prime meltdown.

According to the ANZ Bank, rates could be 9% to 10% by the middle of next year. These would be the highest interest rates we have seen in more than a decade.

This may trigger an economic hiatus, largely brought about by the lengthy period of economic expansion and resultant perception of affluence that has fuelled the consumer credit binge. Add low affordability issues to the mix and there are enough ingredients to make property investors want to batten down the hatches.

However, the educated and cool-headed investor has the opportunity to benefit from any such hiatus. Rather than being distracted by economic guessing games, the strong forewarnings should prompt a plan for how best to retain or attain good growth assets.

For both existing and prospective property investors, this planned approach should involve a pre-emptive strike list of actions to win the day and maximise the capital growth dollars. The items that should go on this list are:

Take a long term view. Property is a long-term growth asset and when properly selected the capital growth should outpace inflation with the asset doubling in value every seven to 10 years.

It is the prime, properly selected assets – underpinned by demand that consistently outstrips supply – that will continue to ride out any economic volatility or fluctuations in property cycles. Don’t try to time the market or punt on short-term profits on a quick turnover basis.

In the year to 30 September, Melbourne’s median price has increased by 13.1% or $50,000. This is the largest dollar increase the Melbourne market has seen in a 12-month period. Some investors may have capitalised on rapid equity build up in markets such as Sydney or Perth, and bought into the Melbourne market. However, unless an investor holds top-quality capital growth assets in the right location and with all the correct selection criteria, then they may fail to realise any “windfalls”. This is because property values don’t grow uniformly.

Read between the lines, even on a bumper auction weekend such as last weekend. It’s the top-quality assets that won the day and will continue to do so.

Ensure asset selection is spot-on. This is crucial. Don’t make the mistake of assuming that the current high property prices in some more compromised sectors of the market are an indication of true, sustainable, long-term value.

Low affordability, in second-tier property with little scarcity value, for example, is driven by a sector-specific set of factors ranging from increased average borrowing capacity and increased land development costs to rising interest rates, increased population growth and high levels of personal credit debt.

If we were to face an economic downturn, a mild recession or more rapid interest rate rises than we have anticipated, we would need to predict which assets would hold firm and which would be the most vulnerable, ahead of time.

Borrow conservatively. Those with conservative gearing and a buffer zone for potential interest rate increases will rule the day. Borrow an amount that can be comfortably serviced and aim to have some equity in any property purchase.

Once the borrowing limit has been determined, concentrate on the best capital growth properties this amount of money will buy. Aim to reduce as much debt as possible, particularly personal credit or consumer debt.

Changing the investor mindset. Investors, like many prospective owner/occupiers, may need to lower their expectations in terms of how much physical accommodation they can buy within their financial limit. This is particularly the case where location is a key issue for capital growth.

There is a paradigm shift among investors. They need to focus on the right location and resultant high land values to buy the most capital growth for their money rather than aiming for larger amounts of physical accommodation.

Rental levels are likely to rise. As low affordability continues to affect the ability of first home buyers to enter the market, we are likely to see rental vacancy rates continue at the current 25-year low. Investors concerned about holding costs should seek a review of their current rent levels with the managing agent to ensure they match current market rates. Carry out a rental review on a more regular basis.

Re-examine loan arrangements. Check with a financial adviser or accountant that the structure of an investment property loan meets individual financial circumstances. If an investor has not reviewed loan arrangements for some time, then carefully examine the loan products that are available and if necessary rearrange financing. Always factor in the possibility of higher interest rates when restructuring or refinancing.

Don’t procrastinate. Waiting for inflation or interest rates to level off or hoping that prices may fall wastes valuable time and, more importantly, robs investors of valuable capital growth in a rising market.

The most sought-after investor sectors of the market are likely to show continued strong growth through 2008. For instance, we are seeing strong price rises in the prime apartment market. Investors have turned to good quality one- and two-bedroom apartments as a more affordable entry point and this demand is now pushing prices higher.

The same properties are also keenly sought by owner/occupiers vying for a foothold in the best capital growth areas. This trend is likely to continue and price growth will remain strong.

This story first appeared in the Eureka Report.