Mortgage rate collapse opens positive gearing opportunities

Last week, SQM Research released data showing that rental yields have failed to materially rise, despite the heavy falls in dwelling values:

However, due to the sharp fall in mortgage rates, SQM Research reports that “some cities are effectively offering cash-flow positive investments after interest expenses”:

With lending rates on the long term decline in Australia and (up until recently) property prices stagnating in recent years, what has become particularly interesting is the effect of the widening gap between lending rates and property rental yields. As average lending rates for home-buyers continue to decrease following on from multiple rate cuts, the gap between these lending rates and rental yields has continued to grow, literally to the point where some cities are effectively offering cash-flow positive investments after interest expenses. But as mentioned in previous weeks, while tempting, cash-flow property investments maybe offering such good yields for a very good reason.

Let’s first look at Hobart:

The chart above presents the gap between the average property yield in Hobart and average variable basic rate across Australia. This shows that there has been an overall uptrend in the gap from the beginning of 2015, and this gap is still rising. It currently stands at 1.75%. Meaning a typical fully geared property in Hobart is still offering a gross 1.75% yield after deducting interest expense.

Now in recent years, Hobart has had a boom on its housing market. Both prices and rents have risen in dramatic fashion. However, rents more so. Hence why acquisition yields have actually gone up. Arguably, one would want to see yields rising to reflect the fact that there is increasing risk (in our opinion) that the Hobart housing market is now in its very late stages of its three year upturn.

There has been a similar trend in Canberra, as shown in the charts below.

Like Hobart, Canberra is also experience a positive gap between yields and interest rates, lending itself to the opportunity of purchasing a cashflow positive property. Mind you, the yield gap is not as large as it is in Hobart,

In this instance, rental yields itself in Canberra have been fairly stable, running at about 5.5% for units and about 4% for houses for a number of years now. So the positive yield gap has simply occurred due to the reduction in lending rates.

Brisbane is also now offering a positive yield after interest rates which is quite significant for a larger capital city. It has occurred due to a rise in rents in the last two years while housing prices have been rather benign, therefore increasing yields. Yields for units are running at about 5.3% gross. While for houses they are running at about 4.1%. As with all other cities, it is the reduction in lending rates that have created this reality. But in this instance the rise in rents In recent times has also been a contributing factor.

So overall, the charts reveal this is not a normal occurrence. While the data we have run only goes back to 2010, in my memory, I cannot recall a situation where a number of our capital cities are offering cash-flow positive residential properties.

As the housing recovery gathers steam, these opportunities will obviously close.

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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