Private Property Issue #37 - Cashflow (Today's market)

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Rising interest rates are hurting property investors’ cash flows.

Bobbie (an investor I’m working with) recently asked: “Why would I invest in today’s market? I’ll have to top up my property by $400(ish) a week while rates are high.”

I answered, "The truth is … it might not be the right time for you to buy an investment property. But, there is always something working for and against you in the property market.”

Here’s what I mean.

What’s the current situation?

12 months ago, it looked like interest rates would stay lower for longer. But property prices were higher.

Today prices are lower (so investors will take out smaller mortgages), but interest rates are higher.

Property investors need to understand how these two factors (together) change the economics of buying an investment property.

Case study: if Bobbie bought a property 12 months ago

Bobbie is looking at investing in a 2-bedroom townhouse based in Christchurch. It comes with 1.5 bathrooms and a car park. The property is expected to rent for $480 a week.

If she had bought it 12 months ago, it would’ve cost about $650,000.

But back then, it looked like interest rates would remain low.

At the time, the 1-year mortgage interest rate was 3.5%, and many economists projected it’d gradually go up to 4.5%.

Here’s what the cash flow forecast looked like at the time:

The worst cash flow year would be in year 4, with negative cash flow of $16k. And the property would be negatively geared over the 15 years.

Case study: if Bobbie bought the property today

Let’s look at the same property, but if it were purchased today.

Bobbie is going to buy this same property. But in today’s market, she’ll only pay $559k – $91,000 less than she would have paid 12 months ago.

So her mortgage will be 14% lower than it would have been.

But her interest rates have almost doubled. They’ve gone from 3.5% to 6%. And next year, they’ll probably go up a little more before dropping back.

Here’s how the cashflow looks today:

Notice how in year 2, the cash flow is terrible. Bobbie will need to top up the property by $360 – $380 a week.

But also see how the property's cash flow becomes positive more quickly. This is because the purchase price is lower.

What’s the overall difference in cash flow?

Let’s compare the overall cash flow of this property.

If you bought this property today – over the next 15 years – you’d top-up the property by $70,686 at today’s high-interest rates

If you bought the property at the same time last year when interest rates looked lower, you’d have to top-up the property by $125,429. That’s using last year’s interest rate projections.

Here’s the trade-off:

A property bought 1 year ago – when interest rates were lower – was expected to have:

• Better immediate cashflow, but would be
• Negatively geared for longer

Whereas that same property bought today will have:

• Worse initial cashflow, but
• will become positively geared more quickly

A trade-off of short-term pain but long-term gain.

So even though interest rates are nearly double, lower property prices have a long-term positive impact on cash flow.

But there’s no use having a better overall picture if you can’t get through the more challenging cash flow.

Remember, there are strategies you can use to help weather the storm during these higher-than-usual interest rate years.

Have a read of our last edition of private property or our article: 7 Strategies To Manage Your Investment Property Top Up

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