Interest rates and rental incomes

Posted by Luke Graham

The 2016 census told us that across the country housing is more affordable than it was in 2006 and 2011. On census night, 7.2 per cent of households had mortgage repayments equal to or higher than 30 per cent of household income. In 2006 it was 8.4 per cent and in 2011 it was 9.9 per cent.

The reason for this is twofold. First, there has been a stable increase in Australia’s median household income. Second, mortgage interest rates are very different today than they were in years past. See the below table:

Year	2006	2011	2016
Mortgage rate*	7.8%	7.8%	4.75%
Household income**	$1,027	$1,234	$1,438
Mortgage stress***	8.4%	9.9%	7.2%
* Average standard variable rate data provided by the Reserve Bank of Australia and charted by the Reserve Bank of Australia and finder.com.au Australian median weekly incomes as collected during respective censuses by the Australian Bureau of Statistics * Mortgage stress is defined in this paper as the percentage of households paying 30 per cent or more of household income to their monthly mortgage payments on census night as collected by the Australian Bureau of Statistics

It is clear that the competitiveness of the Australian housing market means we will continue to pay what we can afford for property that we want. This means that if income goes up and rates go down, our mortgage payments decrease as a proportion of our income and then we can increase our loan size, affording a more expensive property.

What I just explained is a factor of Australia’s macroeconomy and only works on ‘averages’. We have seen this play out in different ways across the national market, where Sydney had much different results to other cities.

But how about the rental market?

There is indeed another correlation we can observe in the property market and that is of rental yields (expressed as a percentage of property value) and rental income (expressed as a weekly dollar figure) against mortgage interest rates.

When mortgage interest rates change, two demographics are affected:

Landlords: landlords feel more pressure to increase or stabilise rents (or even reduce them) when there are fluctuations in interest rates because of the pressure (or lack thereof) they receive from their mortgage repayments.
The bitsa: let’s define a ‘bitsa’ as somebody in the rental market who is on the cusp of being an owner-occupier. This space is typically dominated by first home buyers. As interest rates go down there is greater opportunity for these renters to become home owners, resulting in less demand in the rental market but more demand in the selling market.

How does this affect a landlord’s cash flow?

Ultimately, if you are receiving $609 per week with a mortgage interest rate of 7.8 per cent on a $500,000 property, you would only need $300 per week with a mortgage interest rate of 4.75 per cent to maintain the same cash flow for the same property. See the below table for a break down:

Mortgage rate	Weekly rent	Net weekly cash flow*
4.75%	$300	-$72
7.8%	$609	-$72
* Based on multiple variables including loan-to-value ratio, gross annual income, outgoings and expenses – this can change from person to person and is used for indicative purposes only. Conducted on PIA (Property Investment Analysis) software.

Across most regions in the country we have seen a softening of the rental market and varying results in the sales market depending on their position in the property cycle during this continued low-rate environment.

Posted by Luke Graham, on 26th Oct 2017