Don’t Let Low Interest Rates Fool You Into Buying The Wrong Property

We all know that interest rates are ultra-low right now – in fact they’re the lowest they’ve ever been in Australia’s history. The Reserve Bank of Australia said these low rates are expected to last for another three years. 

This is leading to a whole new generation of Australians, particularly first home buyers, entering the property market and taking advantage of higher lending loans. 

The side effect of this – and I say side effect as it’s not necessarily a negative thing – is that these interest rates are allowing everyone’s borrowing ability to increase the value of their property. 

This is known as yield compression. 

YIELD COMPRESSION EXPLAINED

Let’s look at an example of how yield compression works:

Jane and John have a combined income of $100,000 and they want to know how much money they could borrow in order to purchase a house. They go to a broker or banker and are told with the current interest rate of 5%, they can afford to take on a $450,000 loan. 

They find a property in the market that is selling for exactly $450,000, but then the interest rate drops to 2%. Now Jane and John’s ability to borrow increases because the cost of interest has lowered. 

The lender advises they can now take on a loan of $600,000. However, at the same time, the real estate agent knows that these changes to borrowing are occurring so now they increase the house price to $550,000, knowing Jane and John are going to be able to secure a higher loan. 

This is what is happening Australia-wide right now. The market is adjusting to the low cost of interest and smart sellers, agents and developers are repricing their properties because they know the market can afford to borrow more. 

So, markets are rising around the country. But as property investors we need to carefully understand what is actually going to drive capital growth long term. 

INCOME DRIVE VALUES AND RENT

If your aim as a property investor is to achieve capital growth and create wealth by living passively off the rent from your real estate, then you need to forget about what the short-term market is doing.

Yield compression does not drive value in the long game. Interest rates will eventually go back up and limit borrowers once again. Certain areas that once boomed while rates were low will stagnate or decrease if there is nothing else pushing growth.

Instead, your focus should always remain on the income opportunities of an area, and where can we expect to see an increase in income and wages? 

In great locations! 

LOCATION WILL ALWAYS MATTER

You should only be purchasing real estate in areas where incomes are likely to grow – not just where people can now afford because the interest rates have gone down. 

The Janes’ and Johns’ of the world should be buying around a city area or a well-established location where over the next decade the income is likely to double. 

The current challenge with regional and substandard locations, even those on the city outskirts, is that the earning capacity of the residents there is not likely to grow as much. They simply don’t have the same level of access as those who are closer to high income hubs and greater job opportunities. 

If you want to live off rental returns in the future, you need to invest in locations that are likely to see income growth. 

MAKE SURE YOU’RE PLAYING THE LONG GAME

Don’t be misled by yield compression showing real estate prices go up in certain areas you’d otherwise ignore. These properties are not amazing, they are just affordable right now because of interest rates. 

Long term, you should be thinking about proximity to locations where there are higher incomes so you can reap the benefits. 

If finding the right location or property for you has been a struggle and you’re looking for further guidance, why not join the Positive Real Estate team at one of our free real estate investing nights. Our expert coaches will get you back on the wealth creation track with practical advice and strategies you can implement in your own portfolio. 

Book now to avoid missing out. 

By Jason Whitton

Group CEO Positive Real Estate