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October 11, 2022 by ash

Many investors see opportunities while others fear peril amid rising interest rates.

Lisa Dixson is confident falling property prices, generous tax incentives and strong rental demand are compelling reasons to add to her property portfolio, despite rising interest rates.

The Melbourne mother of two and business management consultant, who has been buying investment properties for more than 20 years, remains confident about the long-term prospects for strong capital and income growth from her portfolio.

“When everyone else is running scared is a great time to buy. Why would you want to put property purchases on hold just because rates are rising!” says Dixson about her plans to buy an investment property through her self-managed super fund.

Six successive cash rate rises by the Reserve Bank of Australia are frightening many buyers as national average prices tumble by about 5 per cent from December highs, according to CoreLogic, with falls in Sydney around 9 per cent and Melbourne nearly 5 per cent.

Major lenders are offering cashed-up property investors discounts of up to 250 basis points off standard variable rates and have cut three-year fixed term loans to below those on offer to owner-occupier buyers.

They are keen to boost investor housing finance commitments, which have fallen sharply with no sign of bottoming, according to government analysis.

Shane Oliver, AMP Capital chief economist, says: “The combination of falling prices and improving rental yields, low vacancy rates and negative gearing starting to become easier or more attractive again (due to higher mortgage rates) is improving the attractiveness of property for investors.”

But Oliver warns investors need to allow for more rate rises and price falls.

Property investors also claim onerous new landlord laws, particularly in Victoria and NSW, are increasing red tape and the cost of maintenance, forcing many to sell their properties.

A drop-off in competition and the possibility of finding a bargain remain powerful incentives for many investors, particularly as the prospect of rising immigration is expected to make the rental market even more profitable.

Finding a bargain

Investors looking for great deals are typically buying unrenovated properties they intend to keep long term, according to Nerida Conisbee, chief economist for Ray White Real Estate, the nation’s largest agency.

“That rules out house flippers planning a quick turnaround and profit,” says Conisbee about a popular buying tactic during bull markets.

A two-speed market is emerging where demand is strong for well-renovated properties that can be easily rented and weaker for unrenovated properties because of high material and construction costs, she says.

According to CoreLogic, which monitors property markets, Australian capital city dwelling prices fell another 1.4 per cent in September, their fifth successive monthly decline.

Alex Jamieson, financial adviser and principal of AJ Financial Planning, says: “Cashed-up SMSF investors are watching closely for opportunities, such as distressed sales, because bargains are beginning to emerge.” They are monitoring cities where prices are coming down the most after record highs last December.

Phoebe Blamey, a director of mortgage broker Clover Financial Solutions, adds: “The profile of property buyers is changing from first-home buyers to investors. Rising mortgage costs are keeping first-home buyers out, making it easier for investors to get back into the market.”

But AMP’s Oliver says investors need to balance improving opportunities compared with a year ago with the likelihood that prices will continue to fall as mortgage rates rise.

“The impact of rate hikes so far has yet to be fully felt,” Oliver says.

“The fixed-rate cliff will hit fixed-rate borrowers hard next year with many seeing a tripling in their mortgage rate and an economic slowdown which could result in an increase in distressed selling,” he adds.

AMP and other analysts are expecting a top-to-bottom fall of 15-20 per cent.

“Property prices normally don’t bottom and turn up until interest rates start falling and this is not expected until the December quarter next year,” Oliver says.

Lenders cut rates

Leading lenders are sharpening their offers to cashed-up borrowers by cutting three-year fixed rates below those on offer for owner-occupiers, points out Sally Tindall, research director at RateCity.

For example, CBA, the nation’s largest lender, cut its three-year rate by 100 basis points to 5.59 per cent for principal-and-interest investors, or around 40 basis points lower than the same term for owner-occupiers.

Big banks typically have much higher standard variable rates than smaller competitors.

Mortgage brokers claim lenders are also offering cashed-up investors up to 250 basis points off their standard variable rates, which vary from around 3.34 per cent to nearly 7.4 per cent.

“Lenders are keen to secure investor business and lock in long-term rental yields,” says Chris Foster-Ramsay, principal of Foster Ramsay Finance, a mortgage broker.

Lender competition for new borrowers – and to retain existing ones – will intensify over coming months as record numbers of borrowers consider their next move, say mortgage brokers.

Nearly 30 lenders are also offering mortgage cashback offers ranging from $1500 to $10,000, subject to loan size.

Tax breaks

Jackie Smith, a design manager, recently invested in a four-bedroom investment property in Queensland’s Deception Bay, about 950 kilometres from her Sydney home.

“For the price of an apartment in Sydney, I bought a four-bedroom house in Queensland,” says Smith, who is attracted by generous negative gearing and capital gains tax concessions.

Mark Chapman, a tax director for H&R Block, says the basic rule when borrowing to fund an investment property is that interest payments on a loan to acquire the property are tax-deductible.

That means rate increases have less impact on the cash flows of investors than first homeowners and owner-occupiers.

Chapman adds: “The tax deductibility of interest is what makes property such an attractive investment for many because it is a key component in ‘negative gearing’, which is the ability to offset losses against other income.”

Investors can also claim a deduction depreciating assets (such as furniture), repairs and maintenance and interest on loans for renovations.

Smith says high rents and strong demand mean her property is positively geared, which means she is receiving more in rental income than she pays on loans, interest, property and management fees.

According to BMT Tax Depreciation, owners can also claim a deduction of 2.5 per cent a year of the original cost of construction of the building for up to 40 years from the date of construction.

Investors are advised to contact a quantity surveyor to assess building costs and depreciation schedules.

When the property is sold, capital gains tax is levied at the sellers’ marginal tax rate but is eligible for a 50 per cent CGT discount if the property is held for more than 12 months. Chapman says: “This basically halves the amount subject to tax and is equivalent to halving the rate of tax paid on the full gain.”

Items that can be deducted from the cost base to reduce tax liability range from the cost of property improvements, legal expenses, stamp duty and valuations through to mortgage termination and exit fees.

Rental demand

Median weekly rents nearly doubled during the September quarter compared with the previous three months, taking the median rent for houses to $500 and $450 for units, according to PropTrack, which monitors rental markets.

“Rental markets are tight but we are seeing the first signs of slowing demand in the regions,” says Cameron Kusher, director of economic research at PropTrack.

Fewer people are moving to the regions as concerns about COVID-19 ease, more are moving back to the cities and increasing demand by owner-occupiers is reducing the number of available rental properties, says Kusher.

Demand in national capitals is also being boosted by the return of international students and an expected immigration increase.

“Tight vacancy rates and less rental properties available are driving markets,” says buyers’ agent Cate Bakos. “It is really hard to get rental properties across the board, particularly at the lower end of the market,” she adds.

Bakos warns investor costs are increasing because of rising interest rates and tougher tenancy laws, introduced in March last year in Victoria, driving up maintenance and building costs.

SQM Research, which monitors property markets, says national residential property rental vacancy rates are less than 1 per cent, which is the lowest since 2006.

AMP’s Oliver adds: “Investors could consider focusing on less inflated cities (like Adelaide, Darwin and Perth) and units where prices never went up as much and where there will be a benefit from the return of immigrants at a time when vacancy rates are low.”

Apartments in Darwin and Brisbane are yielding around 5 per cent, according to PropTrack.