How can house price fall impact new property investors?

Highlights

• Property prices in Australia could decline further as interest rates continue to rise.
• Higher interest rates decrease the valuation of a property, making investors worse off.
• New investors find it extremely hard to resell their property in a rising interest rate environment.

Volatility has returned in the Australian property market as rising interest rates take a toll on mortgage holders. The Reserve Bank of Australia (RBA) has raised the interest rates for the second consecutive month, taking the official cash rate to 0.85%. With declining buyer participation, property prices are falling, bringing a fresh wave of uncertainty for property investors.

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With further rate hikes to come, the property market may be looking at more price drops in the future. This has sparked fears among all market participants, including investors, who could face repercussions of aggressive monetary policy tightening.

Given the possibility of rising interest rates, property investors have become concerned about maintaining their portfolios. The highly uncertain environment has left many investors on the edge as they don’t have the full information to make a decision just yet. Some experts suggest that a wave of panic could urge these investors to sell off their properties in a high interest rate environment, which could aggravate the house price decline.

Relation between interest rates and property value

Higher financing and mortgage costs are a well-known disadvantage of rising interest rates. But apart from impacting the property market directly in the form of high mortgage rates, rising interest rates can also affect property valuation.

Interest rates tend to impact real estate values through the discount rate or capitalisation rate, which are equal to the risk-free rate plus a risk premium. Valuing property through the income approach is similar to the method of discounted cash flow used to evaluate returns on equity and bond investments. The projected lease payments and other property income are also used to determine the total valuation of a property.

In a nutshell, interest rates also affect the availability of capital and the demand for investment. These capital inflows affect the demand and supply for property, eventually impacting property prices. Additionally, property prices also reflect the inherent risk associated with investing in that property.

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How will investors manage higher mortgage costs?

Investors are expected to pass on the higher mortgage rates in the form of higher rent. However, higher rent might not be enough of a relief to investors, who generally seek a portfolio expansion.

The situation could become tougher for investors with multiple properties, as they would have to refinance multiple mortgages. Lenders might have to consider the total debt and apply the buffer rate across all those properties of investors. And a higher buffer rate could tip thousands of residential property investors into financial stress.

Some factors bringing positivity into the market include the record-low unemployment rate and solid GDP growth figures. These factors have kept households afloat even in times of high inflation, including investors. However, wages did not initially rise at par with rising inflation levels, forcing Aussies to turn to their savings as a last resort.

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Problems faced by new investors

Most new investors might see a range of problems propping up in the present climate. The first and foremost issue facing new investors could be the extremely difficult task of reselling their properties. Property auctions have declined in number, with lesser buyer activity visible over the last few months.

Meanwhile, any buyers willing to purchase the property could significantly undervalue the property, landing investors at a loss. In this scenario, managing high interest rate payments also becomes a grave concern.

Individual investors could have a tough time making it on their own, as they face massive competition from investment companies. The lack of adequate buyers also increases competition, and it gets even tougher to beat these organisations.

Overall, property investors could encounter further turmoil in the market. Thus, it is a good idea to keep sufficient savings and build a strong network of sellers and buyers. Though a seamless transition to the high interest rate scenario might not be possible, investors can definitely dampen the effect of the blow.

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