How Coronavirus Has Made Property More Attractive

Posted by Ed McKnight on 20/03/20
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Key points

Key points

  • The Reserve Bank's cut in the Official Cash Rate has caused banks to drop their interest rates
  • Both fixed interest rates and term deposit rates have fallen
  • These interest rate cuts make saving less profitable, and property more profitable
Introduction

How Coronavirus Changes How We Invest

The anticipated economic fall-out from the coronavirus will likely cause structural change in many industries.

For instance, former Air New Zealand Chief Executive, Rob Fyfe, has publicly questioned whether the New Zealand tourism sector will ever recover.

While our view is that this thinking is overhyped, other structural changes have occurred – the decrease in interest rates are the most obvious example.

Why? Because lower and lower interest rates change the incentives and profitability of different asset types.

As interest rates decrease, keeping your cash in a term deposit becomes less and less attractive, while income-producing leveraged assets become more profitable.

The Major Change

Let's Dig Into the Numbers

On Monday 16th March the Reserve Bank of New Zealand cut the official cash from 1.0% to 0.25%. That's a massive 75% cut.

Two days later, ANZ, New Zealand's largest bank cut their 1-year fixed interest rate on lending to 3.05% and decreased their 1-year deposit rate from 2.6% to 2.35%.

So how does that impact how investors make money?

Before the Interest Rate Cuts

Before the Interest Rate Cuts

Before Monday 16th March, the main four bank's term deposit rates ranged between 2-2.6%, ANZ being the most generous at 2.6%.

If an investor put $100,000 into a term deposit, within 12 months, they will have made $2,600.

Let's compare that to property.

Let's say we have a brand new property that is on the market for $500,000, which will rent for $495 per week.

That means the property would have annual revenue of $24,255, once taking off three week's rent to account for vacancy (not having a tenant for three weeks of the year).

There will likely be $8,957.83 of operational costs, like maintenance, accounting, rates and insurance. Then once you account for the interest payments on a $400,000 mortgage at 3.45% interest rates (since there is a $100K deposit), you are left with a cash surplus of $1,497 per year from the property.

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That means investors could get a better cash return from leaving money in the bank, rather than investing in property.

Term deposits would yield 2.6% and property 1.5%.

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Despite that, longer-term investors would still invest in property, chasing capital growth.

While long term capital growth will still exist, the changing interest rates have flipped this cashflow equation the other way.

Post Interest Rate Cuts

Post Interest Rate Cuts

The cut in the term deposit rate decreases the return investors can get from savings from 2.6% to 2.35%.

The most significant impact to our comparison comes from the fall in the 1-year mortgage rate from 3.45% to 3.05%.

That 0.4% decrease is the equivalent of a 1.6% increase in cash yield through property.

Why?

Because the cost of mortgage repayments falls from $13,800 to $12,180, saving the investor $1,620 in finance.

All other costs stay the same, which means that instead of netting $1,497 annually, the investor gets $3,117 from the property in cash.

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Based on the initial $100,000 deposit, the investor can, therefore, get a 3.1% cash return from the property.

So the investor's options in this example are a 2.35% return from term deposits or 3.1% from property + the long term growth in the value of the property.

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These changes give us heart that the property market is going to remain relatively stable over the medium term because investing in residential property for cash returns has become more attractive, and will likely lead more investors into the market.