Last week, the Reserve Bank of Australia (RBA) increased rates from 25 bps to 3.35%. Morgan Stanley Research writes that the RBA’s economic forecasts changed only a little, with inflation returning to the top of the target band in mid-2025.
We expect weakness in macro data over the coming months, but the bar has been raised. Experts at DDP Property forecast 25bps hikes in March, April, and May meetings to a terminal rate of 4.1%. What does this mean for real estate investors?
How Do Rising Interest Rates Affect Real Estate?
A change in interest rates affects mortgage rates and the cost of financing properties, ultimately impacting property-level values. However, supply and demand still have the most significant influence on required rates of return (RRR).
Interest rates are determinants of the cost of debt. When they’re low, it’s good news for property buyers since they can borrow more at a lower price.
When there’s a spike in interest rates, banks and other lenders charge higher rates, making it more expensive for investors to acquire and finance properties. It reduces the returns on investment as the cost of capital has increased.
How to Counter Rising Interest Rates?
The rising interest rates would discourage investments in the real estate market. But it’s only partially true for the Western Australian market, where the lack of supply remains the driving force behind rising rental yields.
Zaki Ameer, Founder of buyers agency DDP Property recommends investing in properties in the $500,000 to $700,000 range. It’s time to dive into the apartment and townhouse market.
Apartments with positive returns or neutral cash flow are safe choices and can provide yield even in an environment of rising interest rates. The most important thing is to look for the right property in the correct location. For example, city centres are attractive locations for overseas students, families, and workers due to the proximity to transportation, infrastructure, and everyday necessities.
Properties in these areas tend to generate higher rental yields as there’s increased competition and demand for these apartment units due to their prime location and amenities.
Likewise, you have already made capital gains in regional areas and growth corridors. In that case, it might be time to invest in townhouses in the middle-ring and inner suburbs might be time.
Real Estate Scope of Inner-City Melbourne Apartment Market
Currently, there are 7,300 apartments under construction within the Inner-City Melbourne region. Over 2023, Urban Property Australia research forecasts that in 2023, 3,000 apartments will be completed in Inner-City Melbourne, below the 20-year average of 3,600.
Urban Property Australia research forecasts that the pipeline of new apartments will decline to 2,500 in 2024 and 1,700 in 2025, a 3-year cumulative total shortage of 3,600 apartments.
While there are another 20,100 apartments with plans approved in the Inner-City Melbourne region not yet in the sales or construction phase, Urban Property Australia’s research forecasts that the supply pipeline has peaked in the short term.
New apartment supply in the Inner-City Melbourne precinct is projected to remain below the 20-year average for the next five years. Urban Property Australia further shows that the supply of new apartments in inner Melbourne has decreased steadily in the past three years.
The supply peaked in 2017, reaching a never-seen-before high. But it fell to under 4,000 units in 2018. Although the apartment supply improved in 2019 and 2020, it fell again in 2021 and declined to under 2,000 new units in 2022.
While the forecast shows a slight increase in the availability of new apartments going forward, there won’t be enough units to match the demand. As a result, investors can expect an increase in rental yield as the market becomes tighter.
The same research also showed that the apartment vacancy rate decreased significantly in December 2022. The lower vacancy rate translated to higher apartment rental yields of up to $480 per week. Since both values are inversely proportional to each other, it’s evident that the constantly dropping vacancy rate will further drive rental yields, making apartments a good investment for the future.
Rising Expense of Acquiring Property
While rental yields look promising, we can’t deny that rising interest rates are also making properties expensive. The Economist data shows that Melbourne and Sydney are in the top 5 Asia Pacific most expensive cities behind the traditional leaders Singapore & Hong Kong.
The acquisition of land to develop, construction costs, and the cost of sale is increasing exponentially. What is $500,000 to $700,000 right now will be $600,00 to $800,000 next year.
Investors must use their savings and leverage capital to purchase property right now. The market growth could outrun individual investors’ ability to acquire property in the next few years.
Where to Invest?
Timing is everything when investing in the current environment. Bairnsdale has the highest home rental yields, with prices starting from $575,000. Interested investors can find middle-ring and outer-ring townhouses in the $600,000 to $700,000 price band.
The best route to investor portfolio protection is finding properties in the affordable price band mentioned above. Established apartment units are goldmines for rental yields, considering their low supply and high demand. The same is true for regional markets and growth corridors, where the scarcity of land drives up prices.
With the investment opportunity crystal clear, it’s no surprise that international investors are taking advantage of the situation and absorbing available stock on the market. Local investors who act now can ensure a secure future and substantial investment returns.
