Current Facts on The Real Estate Climate

With Green Finance Consultant Dimitri Grespos (Green Finance Group)

What happens on the first Tuesday of every month except in January?
The Reserve Bank of Australia Board meets to discuss various issues, then vote on monetary policy.  Monetary policy involves setting Australia’s official interest rate, which is referred to as the Cash Rate.

A quick history lesson on the cash rate:

• The last time there was an increase in the cash rate prior to this year was on 3 November 2010 of 0.25% for a cash rate of 4.75%.
• The cash rate pre Covid (Feb 2020) was 0.75%
• In March 2020, the RBA held two meetings, the first as per normal then an emergency meeting on 19 March. Each meeting reduced the cash rate by 0.25% to help support the economy and financial system.
• On 3 November 2020, the cash rate was reduced by 0.15% to a low of 0.10% to support job creation and assist the recovery of the economy from the pandemic.

From May 2022 to their most recent meeting in October the cash rate has increased by 2.50% (1 x 0.25% increase then 4 x 0.5% and most recently 0.25%) to 2.60%.  The last time the RBA increased rates by 0.5% was in February 2000.

Why has the RBA been so aggressive with interest rate increases?

The RBA statement after the meeting says, “The Board is committed to returning inflation to the 2–3 per cent range over time. It is seeking to do this while keeping the economy on an even keel….

Inflation in Australia is the highest it has been since the early 1990s and is expected to increase further over the months ahead.”

In October and December 1994, the RBA increased the cash rate by 1.0% on each occasion to combat inflation.

Graph of the Cash Rate Target

What is inflation?

Inflation is the increase in prices.  As stated above, the RBA has an inflation target of 2% – 3% and the last reading ending June 2022 was 6.1% with expectations that it will increase to 7.75% over 2022.

We expect some inflation to cover wage and rents increase, however this time, it is different.  The main drivers:

• Supply chain issues because of the pandemic. China’s zero Covid policy in shutting down entire regions which causes delays in shipments; and
• Russia’s invasion of Ukraine. Russia being a major supplier of oil and gas and the disruption of grain being transported.

These have impacted prices across globally.

How interest rates reduce inflation?

Interest rates increases do not directly affect inflation.  They limit borrower’s (individuals and businesses) disposable income, as more money is spent on interest, which will reduce demand which will eventually lead to lower prices (or prices not increasing as quickly).

The following table demonstrates the reduction in disposable income:
$500,000 loan over 30-year term

To explain the above, assume the borrower had a variable rate loan at 2.25% in April 2022, after an increase 0.25% their repayment increased by $65 per month and when another 2.25% increase is factored in, the borrower is paying $697 per month more that they were in April.  This is over $8,000 a year.  If interest rates increase by a further 0.5%, this will add another $153 for an increase of $850 since the start of the year.  If this was $1,000,000 then the increase doubles to $1,700 pm ($20,400 pa).

Now the above household has $8,364 less to spend on discretionary and non-discretionary items.

Flow on effects

Possible recession – the RBA goes too hard which can result in increased unemployment which then forces the economy to go into recession.

Borrowing capacity – this is the amount a person / household can afford to borrow based on their income.  When a bank assesses how much someone can afford, in addition to looking at their living expenses, they use their actual loan interest rate and add a buffer of 3.0% (previously this was 2.50%).   As interest rates increase, borrowing capacity decreases unless there has been an increase in income.  E.g., Someone had preapproval in March 2022 for a $500,000 loan and they had a servicing surplus of $500 pm.  In September 2022, there is now a servicing shortfall of $122.  Their borrowing capacity is decreasing with each increase unless they generate more income.

Residential property prices – as borrowing capacity decrease the number of potential purchasers able to afford a property decreases.  This will likely lead to longer times on market and a decrease in prices.  If a recession were to occur, property prices would crash and mortgagee in possession (Banks acting against borrowers) sales would increase.  National Australia Bank expect national home prices drop 20 per cent overall from their peak, with the bulk of the decline to come next year for most capitals except Sydney, where the correction has hit harder and earlier. NAB expects housing prices in Sydney – houses and units combined – to fall 12.9 per cent this year and 9.4 per cent next year. Melbourne prices are forecast to drop 9.1 per cent over 2022 and 14.1 per cent next year. Brisbane will slip into negative territory this year before declining 9.4 per cent in 2023.

Residential property rents – as borrowing costs escalate together with increases in other costs of owning property, landlords will seek to recover as much of this as possible by increasing rents.

Commercial property prices – as long-term interest rates increase; investors will require a higher return on their property investments.  For this to occur, the cap rate will increase which results in a lower property value.

Commercial property rents – these are generally linked to CPI and the depending upon the lease the tenant may pay the outgoings.  With high CPI, rents will increase and if the tenants also pays for increasing outgoings, this will put strain on tenants potentially putting them at risk.

Solutions

With access to competitive finance solutions from more than 60 banks and secure lenders, and a surrounding team of the most sought-after commercial, asset and residential finance experts in the country, I can provide you with a single point of contact for all your finance needs, both business and personal, including:

• Refinancing, both business and residential
• Funding for new developments or business expansion
• Syndicating large debt transactions
• Capital solutions for mergers and acquisitions
• Cash Flow Solutions
• Equipment Finance, including motor vehicle
• Self-Managed Super Funds (SMSF)

If you would like to save money or secure better terms on your current financing arrangements or would simply like some guidance around your individual or business growth or investment opportunities, I will be happy to meet and discuss this with you and your clients.

Who do I contact if I want to know more about this?

You can contact Dimitri Grespos, Finance Consultant from Green Finance Group directly for a confidential chat on

Mobile: 0481 957 828

Email: dimitri@greenfinancegroup.com.au

For further information on our real estate courses or the current impacts on the ministry contact Victor – Director Validum Institute Real Estate Training via email victor.james@validumgroup.com.au