Interest rates have hit 18%

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I came across a Lotus 123 spreadsheet that I had prepared on a PC back in the mid 1980’s carefully detailing how I might purchase, in thirds with my girlfriend and her sister, a modest property in what was then, truth be told, a hovel, in a suburb known as Newtown. We were proposing to borrow at investment property rates which were then 16%. At the end of the 1980’s investment property rates exceeded 18% and it seemed reasonable at the time to lock in a fixed rate loan for five years at a ridiculously high 15.5%.

The Sydney property market is an investment market like all others. There are winners and there are losers. More than a few baby boomers like me struggled to purchase a home or an investment when the big banks were offering low interest rates of over 18% per annum. We knew then, just as it is today, that it is very difficult to buy into Sydney and should you sell and move to another city, it is next to impossible to buy back in if you have to.

Nothing has changed really. I know my parents really struggled to build their first home in the western districts of NSW back in the fifties. The two of them were making the concrete blocks on site with little more than grunt, a larry, a wheelbarrow and a formwork mould that they had made for themselves.

I wonder how different it would have been for Baby Boomers if interest rates were at today’s record lows below 5%? If the fifties are any guide, probably no different to today, I guess. If I had bothered to research it, I’d probably find that home ownership has always been a struggle.

Now, Architects are not economists. I apply the kiss principle to stuff outside my area of expertise for my own sake, so bare with me. For all the economists and other punters with a point of view… bring it on.

Record low interest rates simply mean that people can, for the time being, service a loan of significantly higher value using their income cash flow. I think a competitive and limited property market that is Sydney, reacts to this by rapid price increases. These circumstances lead to higher risk.

One obvious risk is that interest rates will rise leaving many punters in the situation that they cannot service their loans.

Perhaps equally obvious, but directly connected is that the lenders won’t like that situation at all because their share of the equity in your investment will be put at higher risk in those circumstances. What lenders will do to protect themselves is that they will limit their exposure by increasing the security required to obtain such loans. The banks will do this by requiring more equity from you, regardless of your cashflow capabilities.

To compete, however, the Banks are likely to assign a market value to your prospective property at a figure which is lower than the amount you have to pay to obtain it.

Essentially, it’s the banks who control the rate of growth of the Sydney property market, unless of course, everybody is so cashed up that they don’t need to borrow… which is the case when people downsize from their baby boomer home to a smaller property to live out their retirement.

What is the current situation so far as that is concerned? Well, there’s tonnes of cashed up prospective retirees downsizing, competing against tonnes of cashed up private super funds investing. It’s hell out there.

If you’re one of those people who is thinking of borrowing at record low interest rates and is also thinking how clever it is to be negatively geared, why not try a humble renovation project on your existing home instead. Just sit it out and let the punters fight it out in the trenches until the cashflow settles down.

If you’re in the unfortunate situation of having to purchase into the Sydney market for the first time, then I suggest that you be prepared for the Bank’s valuation to be lower than what you have to pay to buy in.

Back in the day, before capital gains tax and you could see INXS play in pubs we used a PC that had no hard drive. It had 640k of RAM if you were flash, and you put the program disk in one 5″ floppy drive slot and your files disk into another floppy drive slot. It was still pretty good for figuring stuff out.

Gary Finn

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