“Supply is really the number one factor in the residential property market right now,” insists REIA president Hayden Groves, who believes that unless more housing becomes available, rising interest rates won’t reduce national home values.

Speaking on a recent episode of The Smart Property Investment Show, the man at the helm of the Real Estate Institute of Australia (REIA) said the national supply crunch is undoing the negative implications of the Reserve Bank of Australia’s (RBA) cash rate hiking cycle.

Despite the housing market spending the majority of 2022’s back half within an aggressive downswing, which saw prices across the board drop 5.3 per cent last year, the largest drop off since 2008’s global financial crisis, recent data from research centre CoreLogic points to a strengthened market recovery over recent months.

The firm’s Home Value Index (HVI) rose 0.6 per cent in April, its first increase in 10 months, while May saw national home values jump 1.2 per cent, the highest rise since November 2021.

Recently rising prices have occurred against the backdrop of the RBA’s resumption of its rate hiking cycle following the brief reprieve an April cash rate pause offered consumers. And while Mr Groves admitted the latest shock rate rise delivered in June has “taken the wind out of the sails” in the Australian property market, he explained that “we haven’t really seen a significant impact” of the cash rate rises, aside from in Tasmanian capital Hobart.

The primary reason the Australian property market has remained relatively unscathed by persistently rising rates is the strenuous lack of stock the Australian housing market.

“When you have a market of constrained supply, the RBA can do what it likes with interest rates,” he said, adding “it doesn’t seem to impact too significantly on people’s desire to have and need a roof over their head”.

This is evidenced by the recent momentum of the national auction market, with clearance rates having remained above 70 per cent for nearly two months, as opposed to 12 months ago when, following the initial turbulence birthed by the first few cash rate increases of this current cycle, clearance rates strained to rise past 50 per cent.

In Mr Groves’ eyes, such strong results highlight an “appetite for buyers at the moment to secure their homes”.

He noted it is not just owner-occupiers driving this increased demand, with investor interest increasing over recent months given they “generally only ever buy in a rising market or where they feel as if there is some upside”.

He draws the point consistently back to supply, especially given the current climate where, outside of Hobart and Canberra, a chronic undersupply of properties exists in Australia’s major cities, further driving prices up.

“Until that [supply] really starts to change and we start to see a bit more stock come on, this low-supply environment that we’re in will probably continue to put upward pressure on prices despite the RBA doing its best to curb our enthusiasm,” he said.

https://youtube.com/watch?v=FFhffYByZY8%3Fcontrols%3D0

Moving forward, the REIA president expects the national property market to begin evening out, especially with 600,000 extra migrants forecast to arrive on Australian shores by the end of next year, many of whom are expected to settle in Australia’s more affordable capital cities, such as Perth.

Casting a gaze away from the economic drivers of Australian property, Mr Groves declared “there’s a lot of upside” in the market at the moment, largely driven by “this inability to get more supply into the market quickly”.

“[This] is inevitably going to continue to have upward pressure on price for the foreseeable future. I can’t see it going away,” he concluded.

Like most people, I started my own property investment journey in direct residential property investment, and for good reason.

During the early stages of building a property portfolio – what many of us call the “accumulation phase” – investing in residential property can bring valuable benefits that are important for portfolio growth. 

Obviously, one of the main benefits is the ability to accumulate capital and providing you have followed investment fundamentals and purchased a property with the right prospects, history has shown us that residential properties can generate significant capital growth over time.

The important implication of this in the context of portfolio expansion is the ability to leverage this built-up equity (also supported by the gradual reduction in debt as you pay down your loan) to fund further property purchases.

This is one of the key reasons why I believe, at least, for the majority of investors, that residential property is the logical place to start when building a property portfolio.

However, it’s also my opinion that this isn’t necessarily where you want to end.

Why your property strategy should evolve over time

Let me explain.

Your financial goals generally won’t remain static over time.

While many of us start out in property investment with the goal of building capital, as we get further along the investment journey and begin approaching retirement, we will often want to transition towards more of a cashflow focus to supplement or replace wage income.

For some, these priorities may come even earlier but for those with irregular or unpredictable income, such as farmers or the self-employed, supplementary income can play an important role in smoothing out yearly cashflow.

Equally, investors who already have a significant amount of capital allocated to growth-focused assets may want to consider diversifying their strategy earlier to balance their existing portfolio. 

While it is certainly still possible to generate high yields from residential property, this may come at the detriment of capital growth. And once you’ve factored in ongoing expenses and maintenance costs, your net rental yield will be reduced.

An alternative income-producing strategy that investors often overlook is commercial property.

Commercial property as an income-generating strategy

When it comes to commercial assets, their value is largely based on the income return they provide to investors.

Rental yields tend to be higher than residential property (commercial yields can range from 5-7 per cent), which is in part because commercial landlords can pass on their rental outgoings as part of their rental charges to tenants – costs borne by the owner in the residential space.

A more significant reason is because of the longer lease terms generally associated with commercial assets. 

Comparative to the typical 12-month lease on residential properties, it’s not unusual for commercial properties to have an initial lease term of five years or more.

This can be highly beneficial in providing investors with a regular income stream without the need to renegotiate lease agreements and replace tenants on a regular basis.

The implication of this, of course, is a higher risk component should that asset fall vacant.

Comparative to residential assets, commercial properties can stay vacant for months, or even years, while landlords look for a replacement tenant – especially if the property isn’t well suited to modern requirements.

This risk factor is also why commercial property isn’t for everyone.

Why is commercial property overlooked?

So, for those who do have the risk appetite, why is commercial property so often overlooked?

One reason, which has been backed up from the findings of a market survey we conducted at Westbridge Funds Management, is that many property investors simply don’t know enough about this asset class to invest with confidence.

In fact, over half of our survey respondents who said they wouldn’t consider commercial property specified this as an underlying reason.

This awareness gap is perhaps also reflected in the fact that fewer than one in five (16 per cent) of our 700 respondents had exposure to commercial property, despite 70 per cent targeting cashflow as either their main priority or as part of a blended portfolio.

Beyond this, a further 22 per cent of respondents who wouldn’t consider commercial property perceived commercial assets as being too expensive.

Investing in commercial property through a managed fund

When considering commercial property as a direct investment, the reality is that a high-quality asset would likely require an entry price of $5 million or higher.

This presents a significant obstacle for most individual investors, who may also be hesitant to allocate such a large amount of capital to a single asset due to the associated risks.

An alternative is to invest in commercial property through a property fund or syndicated investment structure. This is essentially where you pool money alongside other investors to fund the purchase of an asset (or in some cases, assets).

For larger-scale assets like commercial property, this pooled structure can play a significant role in enabling access to opportunities at a significantly lower capital outlay than investing directly – and with less risk exposure than concentrating all funds into a single asset.

Certainly, for me, these vehicles have played a key role in expanding my own portfolio focus into the commercial and residential development space. 

Of course, syndicated investments – and commercial property in general – certainly aren’t everyone’s cup of tea, and they carry implications and risks of their own that investors need to be aware of.

But it’s important that we know the vehicles available to us when assessing the opportunities to help us meet our ever-evolving investment goals.

In the current elevated interest rate environment, it pays more than ever for property investors to carefully consider their property portfolio.

As I say in my book, Bulletproof Investing (page 105), “Cash flow and growth are interrelated in any investment, almost like a fulcrum or seesaw.”

So, how can you achieve your portfolio growth and mitigate risk to cash flow?

I’ve put together my key tips relevant to all investor profiles, from first time property investors through to those keen to grow their portfolios.

1. Only buy properties that pay 4 per cent rental yield or higher

To ride through this economic climate, your investment strategy should focus on properties yielding a minimum 4 per cent. This leaves more dollars in your hands, between 2-3 per cent after expenses, easing the impact of any interest rate fluctuations.

We buy property because we want it to grow in value, that’s what will ultimately make us wealthy out of property investing. But we need the property to pay for itself too, otherwise we won’t be around long enough to see the growth.

2. Only buy new properties

One of the fastest ways to churn through expenses on an investment property is improvements to the dwelling, renovations, and upkeep. Focus on new builds which will be low maintenance and produce positive cash flow from the first day, rather than require expensive ongoing maintenance.

Depreciation is also the single biggest cash flow benefit afforded to property investors. Why? Because it’s the only expense we don’t actually pay. It’s a paper loss that, instead of paying out of our rent, it is paid for by the tax we would otherwise pay the Government. 100 per cent of the cost of building a house is tax deductible.

3. Holding property must cost less than 10 per cent take home pay

My rule of thumb is the cost of holding a property should not exceed 10 per cent of our after-tax take home pay – regardless of whether interest rates are high or low.

While we can’t control interest rates, we can manage the risk by making careful decisions when it comes to the properties we buy.

I’m not a fan of selling property if you can avoid it. The only time I’d encourage people to consider selling is where the cost exceeds 10 per cent of take-home pay.

4. Don’t buy units or townhouses

Another sure-fire way to burn through expenses on an investment property and reduce your rental yield, is through body corporate fees. Freehold land and houses don’t have this added cost, where all units and townhouses do. Also, as we know, the true value of any property is in the land, something units can’t offer.

5. Buy at the affordable end of the market

Vacancy rates are often overlooked by property investors, but it is a critical piece of the puzzle in delivering high yield and cash flow. You want to ensure you have a tenant paying you rent 50 or 51 weeks in a 52-week year.

In this respect, the less affordable the rent is, the fewer tenants you have to pick from.

Buying properties that are affordable is important – at or below median house price, and where the rent you’re budgeting on doesn’t exceed 30 per cent of the average income in the area.

6. Pay interest only

Unless you’ve paid off your own home, it doesn’t make sense to pay down principal on investment loans that earn an income and are tax deductible, while you still have a mortgage on your home – which doesn’t earn you rent, nor gives you a tax deduction.

The bank doesn’t want this either, so make sure you set your loans up to be interest only across all your investment properties. If you’ve paid off your home loan, only then should you be paying down your investment debts.

7. Lodge a tax variation when interest rates are high

Interest rates go up and down. The reality is, if we hold an investment property over 10 years, in six to eight of those 10 years we’re going be in a normal inflation environment (2 to 3 per cent) and pay an interest rate of between 4 per cent and 5 per cent on our mortgage.

For 1 to 2 of the 10 years, our interest rates are going to be high, and for 1 to 2 of the 10 years our interest rates are going to be low.

When interest rates are high, like they are now, a great tool that’s available to property investors is to lodge a tax variation. This means, using the example below, rather than waiting until the end of the year to receive the $12,395 tax refund, property investors can receive this progressively throughout the year by paying less tax in their weekly, fortnightly, or monthly pay.

CASE STUDY

Property price: $750,000
Rent at 4 per cent: $30,000 p.a.
Net rent 3 per cent: $22,500 p.a.
Interest on 80 per cent loan at 6 per cent: $36,000 p.a.

Cash flow before tax: $13,500

Depreciation: $20,000 p.a.
Paper loss: -$33,500
Tax refund (assuming 37 per cent tax rate): $12,395

After tax cash flow:

• -$13,500 (before tax cash flow)
• +$12,395 (tax refund)
• $1,105 p.a. (after tax cash flow)

As you will read in Bulletproof Investing, the message is you need to have a plan when it comes to cash flow and the plan should be to find a healthy balance between cash flow and growth, regardless of what asset you’re choosing to invest in.

When you combine the three aspects of bulletproof investing – investing in land, using leverage to accelerate your progress, and planning cash flow well, you ultimately unlock the secret sauce of all investment gurus: compound growth.

When you invest in rental properties, finding quality tenants can make the difference between a successful investment and a failure. Vacant properties can be the weak link that causes your money not to grow as fast as it could.

With the right knowledge, you will understand how vacancy rates can affect your investing strategy and learn how to go about finding high-quality tenants that will help your assets grow fast and steadily.

What is a vacancy rate?

Vacancy rate is a crucial metric that real estate investors use to evaluate the performance of a property. It refers to the percentage of unoccupied units in a rental property at a given time. For example, if a building has 100 units and 10 of them are vacant, then the vacancy rate is 10 per cent.

Analysing the vacancy rate

The vacancy rate is a term that most investors use to directly impact their financial outcomes. Vacancy rates are often used to determine the rental yield of rental properties when comparing them with other properties in the same suburb.

Nowadays, the number of vacant properties is on the rise. Vacancies are higher than they were a decade ago. This has caused the real estate market to face its share of challenges in a way that’s becoming endemic across Australia’s capital cities.

A high vacancy rate indicates that the property is not generating as much rental income as it could, which can have a negative impact on an investor’s return on investment. Conversely, a low vacancy rate suggests that the property is in high demand, and the investor is likely to earn a steady stream of rental income.

Vacancy rates can also provide insight into market conditions. For example, if the vacancy rate in a particular area is consistently high, it may indicate an oversupply of rental properties, which could make it difficult for investors to find tenants and generate a positive cash flow.

How do you compute vacancy rates?

To compute the vacancy rate in real estate, you need to first determine the number of vacant units in the property and the total number of units in the property. The formula for calculating the vacancy rate is:

Vacancy Rate = (Number of Vacant Units / Total Number of Units) x 100

For example, if a building has 50 total units and 5 of them are vacant, the vacancy rate would be:

Vacancy Rate = (5 / 50) x 100 = 10%

This means that 10 per cent of the units in the building are currently unoccupied.

It’s important to note that there are different ways to calculate vacancy rates depending on the specific circumstances of the property.

For example, if a property has some units that are not currently rentable due to renovations or repairs, those units should be excluded from the total number of units when calculating the vacancy rate.

Additionally, some property managers or landlords may use different formulas or methods to calculate vacancy rates, so it’s important to understand the specific methodology used when analysing vacancy rates.

Factors affecting vacancy rates

Vacancy rate is an important consideration for real estate investors, as it can provide insight into the financial performance of a property and the broader market conditions in which it operates. A number of factors can affect vacancy rates in a given area, including:

Economic conditions

The overall economic health of a region can have a significant impact on vacancy rates. In a recession, for example, people may be more likely to move back in with family or friends, reducing demand for rental units and increasing vacancy rates.

Population growth

Areas experiencing rapid population growth may experience a higher demand for housing, leading to lower vacancy rates. Conversely, areas experiencing population decline may have a surplus of rental units, leading to higher vacancy rates.

Housing market conditions

The supply and demand dynamics of the housing market can also impact vacancy rates. In a tight rental market with limited supply, vacancy rates are likely to be low. In a market with a surplus of rental units, vacancy rates are likely to be higher.

Seasonal fluctuations

Seasonal fluctuations can also impact vacancy rates. For example, in college towns, vacancy rates may be higher during the summer months when students are away.

Rent control laws

Rent control laws can limit the ability of landlords to increase rent, which may lead to lower vacancy rates as tenants are less likely to move out to find cheaper housing.

Availability of new construction

The availability of new construction can also impact vacancy rates. Areas with a lot of new construction may have higher vacancy rates as new units are added to the market, while areas with limited new construction may have lower vacancy rates.

Housing affordability

The affordability of housing can also play a role in vacancy rates. In areas where rental prices are high relative to income, vacancy rates may be higher as tenants struggle to afford the cost of living.

Conclusion

Vacancy rates and rental conditions in general might change fast, so seize the opportunity while it is still available. If you own one or more investment homes, you should speak with your property manager to obtain a sense of the neighbourhood and learn about your alternatives.

Could refinancing prove valuable for home owners and investors looking to unlock extra capital this year? According to one financial expert, yes.

As some 800,000 Australians prepare to exit their fixed rate mortgage over the course of 2023, Paul Glossop, chief executive officer at Finni Mortgages, recently revealed how the strategy could be harnessed by borrowers throughout the year.

Following the Reserve Bank of Australia’s (RBA) decision to enact 10 consecutive cash rate increases between May 2022 and March 2023, in which time the cash rate rose from a record low 0.1 per cent to 3.60 per cent, Mr Glossop revealed the nation’s “probably getting to the point where assets are worth at least 10 per cent less than what they [were] worth this time last year.”

As a result, “the cost of holding those assets has increased exponentially compared to where it was this time last year,” leading to many Australians feeling worse off. However, he noted this is the intention of the RBA’s monetary policy.

“We’re going to have less money that’s going to be free and available every single week and month to do what we want with,” he conceded.

More than a year of economic headwinds has meant the cost of holding assets, particularly homes, for many Australians have increased, while the actual asset itself has “obviously decreased quite significantly in value.”

According to CoreLogic, national home values plummeted 5.3 per cent on average in 2022, the largest calendar year decrease since the Global Financial Crisis (GFC), while repayments since the RBA’s first cash rate hike early last year have leapt by over $1,000 for some borrowers.

Speaking on an episode of Property Finance Uncut, Mr Glossop concedes that many of those mortgage holders bracing to roll off their fixed rate over the course of 2023 can almost “guarantee that every single one of those fixed to variable debts is going to be a higher debt than what it was fixed for.”

“So, if you’re thinking that you’re going to roll from a fixed debt to a variable debt and that variable debts are going to be the best absolute debt that the bank’s going to provide you in the entire market, unfortunately, you’re going to be very sorely mistaken,” he said.

Under such circumstances, he believes borrowers should have one eye on hunting a better rate.

“To put it simply, if you are a principal place of resident sub-70 per cent loan-to-value ratio (LVR), sub-60 per cent LVR, and you haven’t got an opportunity to get a 4 per cent rate on that debt, there are definitely lenders out there who are offering in the fours, even if it’s a 12, 24-month introductory rate.”

From his perspective, there is an “enormous amount of money that’s on the table for most people” by refinancing and “looking under the hood.”

For investors, he felt that “not only is there a chance to refinance to a lower rate, but even getting equity out and starting to think about investing with that extra money that’s available.”

Highlighting that the potential to refinance is still there even if a mortgage holder’s loan has already reverted to variable, he stressed the importance of doing a financial health check, stating that “this is the opportunity to actually get in touch with your broker because this is the time to actually sharpen the pencil. 

“That’s where a good broker should be having these conversations with you,” he concluded.

Listen to the full conversation here.