Breaking down the 3 property pillars

This is a Momentum Media production. Nerd alert! Property nerds. The home for data-driven property investors, where we uncover Australia's hot and cold markets, latest headlines and trends. Hello nerds, this is your property nerds and it's Arjun here, InvestorKit's head of research, and I'm joined by...

Leigh Paliwal, your director of Hills Finance. Well, we've got some exciting news today and actually a different style of episode today that's all about something different that we want to do every six months. And if you all love it, we'll start doing this every three months. I think what will make us bring it down to three monthly is if the policies or if the things that we see in the environments of housing and finance change rapidly, then we'll bring it down to three months. But for those who are new to the show, each month, Lee and I, we join heads and we nerd out, hence the name Property Nerds.

And it's a safe space for anyone that's really wanting to learn more about housing finance, headlines, trends, and go through that. But I guess what we do in this episode is a little bit different where we'll go through the three core areas of what's really happening in the markets, which we mentioned is finance, number one. The second is policy. And by policy, I mean policies in the space of governments, industries, or finance itself that could structurally shift a few things as lead indicators. And then the last thing is property, just core trends in property for people to hear about, learn, understand based on some of the data and research we're seeing.

So these are three core areas and instead of doing our typical research or finance reviews or certain guests on, we'll make it a thing where every six months we get to break down these three core pillars and just go deep into what we think the flavor will be for the next six months off the back of these three. So it's our first time doing that and we look forward to sharing more episodes like this and going through those three core pillars so people can get an understanding of things to expect over the next six months. So without any ado though, our favorite part is finance. Lee, what's happening on the finance front? Yeah, well, since last episode, there has been another cash rate increase as we should all be aware of.

If you're not, then, well, you're probably not listening to the news. So essentially, obviously the cash rate's gone up another 0. 5% as of July. That's now been applied as of today for majority of lenders. And now the cash rate sits at 1.

35%. So I guess that's another increase three in a row now. And obviously there's a lot of talks from different lenders, bank providers, all that, of predictions of where the cash rate will sit by the end of the year. I think on that cash rate piece as well, you know, one thing I learned just reflecting on what you said there is that there used to be this moment where everyone used to think that 0. 25s were the only way rates could go down and go up.

And that's not the case at all, right? I mean, it's not this thing, it's not the system where it's meant to go up or down at a 0. 25. It's set by the RBA based on, you know, what they're feeling is required to either move and stimulate the economy or slow down the economy. So this is a perfect example that things can move faster and more frequent and at larger jumps in comparison to that somewhat, you know, myth or rule that people think that's a 0.

25 for everything. It's not the case at all. But Lee, on that note of the interest rates rising up and the bank's forecast, what are some of the forecasts that the banks out there have been putting? For example, ANZ was saying 3% by the end of the year cash rate. I mean, last episode we talked about, you know, 2019 pre-pandemic cash rates were sitting at 1.

5%. And we're talking about how it's currently normalizing. So it's not all doom and gloom, right? But we're now sitting at 1. 35% shortly after us just talking about that last month.

So, I mean, yeah, I mean, that's one prediction and that's kind of an indicator of what many others are saying is around that mark by the end of the year. I think that, yeah, the 2. 5 to sort of 3 has been what's been thrown around by many of the banks in their forecast. And then that 2 to 2. 5 is where the RBA is at.

But I think if there's anything the Australian public is going to really be frustrated with is the fact that the two groups who are saying them, the banks and RBA, have not been very reliable over the last year or two in what they're going to see or they're going to do. And the banks from their 30, 40% decline forecasts and then the RBA from we won't do anything in 2024 until 2024. These have been absolute letdowns to the general public, not because of the outcomes of them, but just more so because of reputable source of information for Australians to follow, trust in, who run and move core parts of our economy, the flowing of money, right? And they've just gone in the complete opposite direction of what they said. But I think what it does share with me when I see that 2.

5 and 3% outcomes, you know, firstly, as lending has been flowing out to people, they have been assessed in the past at rates of between 5. 5 to 7%. And so the 5. 5 on the low end back when assessment rates were that percentage buffer on top of rates, and that's when rates were at the lowest at 0. 1 at that time.

And then the high end of 7% is back when the assessment rates just used to be a flat 7%. So that's where that 5. 5 to 7 comes from. I think as we go up to that 2, 2. 5 and above, if it goes to that level as per bank forecasts, then obviously those assessment rates end up getting tested in that territory because people's rates would, I guess, be near the 5% at that point, should it go to that amount.

It's not a large number of people at that 5. 5 assessment rate end because that would have been just more recent finance take up in the recent years. Because back when you and I were in our banking days in CBA, 7, 7. 5. So I still think there's a lot of preparation in the household finances to be able to cater to that.

But a lot of people in recent times who've taken some of those loans out with the hope or thought that interest rates would remain here forever, I think there's a little bit of just bounce or shock in those households that just need to react to the speed of change that's happening here. Because obviously it's happening much faster than the way down. Because on the way down, it wasn't this quickly. I mean, we've been decreasing since 2012. That's not a three months and you're back up to 1.

5 kind of thing. So yeah. That's right. So I guess a couple of things off the back of that cash rate increases. Yes, the banks are applying the full cash rate increases to their variable rates.

And number two, yes, if you've got a variable rate on current variable loans already settled, in terms of repayments, the banks are notifying you pretty much a month after that rate has been applied to then increase your repayment as well. So they're automatically doing that from what we're seeing across all the lenders, increase your repayments. And so I guess we did talk about that last time around in terms of you're applying for new lending and how are we assessing that to make sure we're factoring all these changes in? Well, firstly, if the cash rate increase has been announced, applying that into our servicing calculations to preempt once that gets applied. Because if you are pre-approved or trying to apply for pre-approval, if you have that approval already in place, the lender is essentially saying, even if you are already pre-approved, but there is a cash rate increase and we've applied that to variable rate, which we know that's happening, we would need to reassess your borrowing capacity again.

So essentially making sure we're getting that all factored in at the time of application or throughout pre-approval placing for the client is quite important or preempting that at the initial stages. So that's something that's happening and making sure that we have to be very mindful of on your new applications. But in saying that we spoke about this last time as well as there's cash assessment rate buffers that's being applied well above the interest rate that's being provided to make sure you can afford that with 3% extra assessment buffer applied to the rate actually given. Also, we've been scrutinizing living expenses for a long time now as well. And so anytime for like any application that you're doing, it used to be that, oh, you just kind of say, I pay this much in expenses and this is what my repayment on the loan is and all that kind of stuff.

Well, for a while now, a good year or two at least, everything is on the table, everything's verified and everything's factored in very well upfront for your application. So there's no chance of you, I guess, overcompensating for what your borrowing capacity would be with all those factors involved. I think what that does is it definitely shows how solid our credit policy in terms of the stringency of the banks and what they've been reviewing and checking right over the last couple of years. So that's definitely a core part that that really, really shows. But when it comes to data, I know housing finance data for May ending is out now.

It is a little bit lagged because Just so you are aware, guys, in terms of, you know, investors, like investor rates are much higher than owner-occupier. If we're talking about where your rate should be sitting at at the moment, from a variable rate today, this is July, mid-July, we're talking about mid to high threes, and that's both for P&I and interest only. And that's for the investors, right? Yeah, that's for the investors, okay? So really, you should be reviewing your interest rates and your loans if it's a bit lower than that.

Sorry, higher than that. Yeah, no one wants to jack up their rates. No one wants to jack their rate up, but if it's higher than, if you're in the, you know, fives, fours, you can get lower than that. Definitely. And on that note as well, I think when it comes back to that property strategy point, sure, for those who went to fixed rates before and they came out or felt like winners in that low interest rate time, moving ahead, if your goal is really scaling a portfolio, being that person on fixed rates, it's not so much about that anymore.

Like if you're thinking, hey, RBA cash rates will get to three, and if they do get to three, my interest rates, I want to save them now, maybe those fixed rates look good at five or six or four or five. I'd be cautious about that because when we build scalable property portfolios for clients, a variable rate offers immense flexibility. And to get ahead in property portfolio building, it is a finance game, which means you sticking with a one bank or two banks max is not what's going to get you there. It's about, you know, us collaborating like we do for many clients and Lee and I being able to go, hey, we need to look at these banks for this or another bank for that. And by doing it this way, we're able to then make sure you're getting your portfolio scale.

So that's a big key note on the refinance side. And it's super important because on that note of refinance, you know, we're seeing some rises. What are the numbers you're seeing, Lee? Yeah, so back to the ABS lending indicators for external refinancing for the month of May, total housing rose by 3. 1%.

And that was 16. 6% higher compared to that same time a year ago. For owner-occupier housing, it rose by 2%. And that was 19. 9% higher compared to the same time a year ago.

Investor housing rose by 5. 7%. And that's 10. 2% higher compared to that time a year ago as well. So, you know.

Investors are back. They really increased by 5. 7%, taking out some equity there. Rescheduling debt. Yeah.

You know, all the things we spoke about. So that's all part of growing a portfolio is, you know, one bank has one policy. Why not go to a broker that has access to 40? Actually, another thing on that note of equity, such an important piece I just thought of then that we didn't touch on is the power of accessing equity to just leave it in offset. Yes.

Like that's such a crucial thing. Like, I mean. Having access to your money when you need it. Buffers, right? Buffers, renovations, increasing cash flow in properties.

To give everyone some context on a more personal note, I can give an exact address for those as well who want to check out what happened and everything like that. So 33 Alcorn Street, Bellbird Park. So that's my own investment property. It goes back to 2016. I bought it.

But I want to use this as a bit of an example of what people can do to tackle rising rates, to tackle cash flow, and to think of wealth creation. So for context, that property was rented for $340 or $350 prior renovations. I spent $28,000 just over. And the outcome of that $28,000 was to replace carpets, paint internally, new shower rows, shower taps, and new vanity benchtop with sink on top, new kitchen benchtop, dishwasher, oven, stovetop, pergola, and window furnishings. Now, if you're all wondering, hey, Arjun, it sounds like you've got 1970s prices.

It is because I'm in this industry, and it is because my team and I have purchased over 350 properties. So as a result, network and relationships help. And what that's, I would say, in the common pricing world, like just average investor going out to other trades, that may be a $40,000 reno. But for $28,000, that's what it is. Let's even say it's $40,000 just for the sake of this example.

But it was $28,000 exactly. You can go and see before and after photos. REA will help see that, and you can kind of just click through before and after. Yeah, check it out. The outcome here was that the rent moved from $340,000, $350,000 to $475,000.

That's $125 per week. Now, $125 per week, if you look at that on an annual basis, and then if you take away property management on that money, that's just over $6,000 in increases of cash flow. Now, I first purchased that property for $292,000. I took a 90% loan, and that loan was $260,000. I then increased that loan to take out equity.

So I think I took out about $40,000, of which I used that $28,000 for the renovations. So my loan owing is about $302,000 then. So $302,000, if I increase those interest rates by the 0. 11 or 1. 2 that's roughly happened now, or 1.

11 or 1. 2, heck, I'll even move it up to 2% to be conservative for factoring in maybe the next month or two's rate rises. That's $6,000 of increased interest. So you can see that $28,000 in spend or $40,000 in equity loan has increased my rent by $6,000 to then, and that's net rent after property management, by the way, to then also balance the $6,000 in interest rate rises of 2% higher, which is not up to that 2% higher yet because it's 0. 1 to 1.

1. So it's just over 1% higher. So the rates could go up 0. 5 for the next two months and it would be neutralized. And this is not including any additional depreciation from the renovations or write-off.

And this is not including any capital growth that's happened as a result of renovating the property to make it more appealing because I'm sure a house that rented for $340 is valued differently to a house that rents at $475. Yeah, definitely. So I guess on that note of equity, as people who reach out to Lee or speak to the team at Hills Finance, consider refinancing, accessing equity, and just whacking it into your offset account. Take a moment to reflect on your portfolio and just go, are there any quick wins that I can do? Ceiling fan light combos, split systems, refreshing carpets, full paints, and how much is that ROI positive outcome?

Is it a scenario like mine where the rents go up $125 after a $28K exercise? And in retail world, call it $40K. Or even if it goes up $100, not quite $125, $50. Because $50 and $40K spend, if you were to buy a $50 per week rental on a $40K property, that's not too bad either, right? On that increase, that's pretty good.

So I think just on that note, when you are refinancing and you are looking at equity, there is going to be a lot of people with a lot of equity if you've owned a property for two years or more. Because you've just gone through 40% plus in asset value rises. Because hopefully it's not an apartment, it's a house. But 40% plus in asset rises as per ABS. And that ties in, like side note, or off the back of what you're saying with the last podcast, we spoke about the tight rental vacancies.

If you're coming up to renewal of lease, for example, you're considering, hey, I've had this increase in equity, it's time to review my loan. Also, what can we do to improve that property, right? To bring in a higher rental return. Yeah, that's the game. So it's a massive overall strategy.

So Lee, then that's a big part of that finance piece when it comes to increasing finance take-up, increasing rates, all the lender policy stuff you've mentioned, which is just to be really mindful, take care with as the rates increase, your pre-approval may be adjusted or things change. We also talked about where we anticipate the cash rate going to. How about we move into the world of policy now off the back of finance? So finance was that first update for what we're seeing that's happening out there. But on the policy front, there's been some big changes.

What's happening on the land tax front, Lee? Yeah, so a big one for investors is the announcement that Queensland are launching a new land tax policy for the 23-24 tax year. And that's where they will take into account properties you hold in Australia aggregately for this land tax calculation, so long as you hold one of those properties that are within the Queensland state. So, yeah, I mean, did you want to go through the actual calculation of how that land tax is calculated? Well, look, I mean, I think there's a really good example on the Queensland.

If you just Google Queensland land tax and just jump onto the Queensland state's relevant websites there, they So I think that's where when I hear this rule, it is horrible. I'm not a fan of it. It's just silly because there are going to be the people that they're hoping to do good by are actually going to be impacted greater. And that's not the investors I'm talking about. I'm talking about renters.

It's proven from our last podcast that renters were absolutely stung by years of an intervention, policy changing, investor appetite shifting, and investor finance ultimately dropping. Over a longer term, there's a proven trend that governments don't want to be landlords. They're not putting out the housing that's required from a social perspective to allow for more rentals to be in the marketplace. So as a result, the investors are the ones funding it. So how dare you come in and keep stinging all the investors?

So what that now means is if you want to take a look across the ditch, look over to New Zealand and see what constant pinging of the investor, making life difficult for lending to the investor, policies for holding an investment property looks like, you're going to see rents fly up just as they have now. Rents will have a boo, crisis, whatever you want to call it, 2. 0 over the next few years in Queensland because of policies and silly policymaking like this. So I'm quite upset by it, but at the same time, life goes on for investors. We're very fortunate to be doing what we do in building the portfolio that we have.

But at the same time, I'm going to be upset for all the renters who are going to be doing it tough. So expect rents to rise. Investors, you will be okay. Your capital growth will continue on with the fundamentals of housing that exist in Australia, and your rents will skyrocket. Now, whether that covers all your land tax bills, some of it or not, there's a lag attached to this and it will take time.

And we'll just need to see and sit back. For now, for us and our clients, we're operating, buying and scaling property portfolios to do with the right locations and the tax policies and things are just a cost of doing business. Golden nugget though, for I guess first-time investors or investors that have not invested in Queensland, you're obviously going to continue to invest outside of that. No, because I think the good question, Lee, it's really important for the people considering Queensland. I think it doesn't change a thing.

And the reason why is I think of those three scenarios. What if it gets removed? Why did you make a decision and kill a state because of that? What if it gets removed scenario two later on? Why did you make a decision and kill off a state because of that?

Number three, what if everyone jumps on the train and does everything? It does the same thing in every state. Why did you choose a state or not choose a state because of that? So all three scenarios point to it that you should just go back to doing what you always do with fundamentals, which is choose the best location. And the second fundamental is not tax perspective.

It's actually location and diversity with your asset choices. And it's actually just diversity across locations for the sake of different drivers. The drivers of Wagga might be different to the drivers of Toowoomba and Bundaberg. So I think that's the purpose of investing and that's the foundations of successful investing and taxes and rents and things. The input and output will work itself out.

So that's kind of my advice there. Cool. Or my thoughts. All right. So the next big policy change that has been announced recently was that New South Wales has introduced to offer first home buyers the option of paying stamp duty or instead an annual land tax option starting from mid-January next year.

Yeah. So this is big, very, very big news. Now, people can sit on the calculators and break down all the numbers they want. Oh, no, in 12 years, it's now worse off. Or, oh, no, in six years, it's better or worse off.

Just remember, any policy the government wins long term, we need to understand that. But it's not about comparing that, right? Because the whole point of policy input is for the government to win. And hopefully we win later as a result of a strong government. Example, all the stimulus that printed off and all the support and all the luxuries that we were able to have the support of during the pandemic.

But let's put that to the side and let's just focus on the outcome that the government will win. So let's not get caught up on the stamp duty land tax, which one's better by which time. But look at this year, it's an ROI negative and this year it's an ROI positive. The main shift that this will cause is a shift in the amount of money you need to get into the housing market. This is the big part.

Imagine all the years of savings that are eroded as a result of not having to put that much money away. Like all these years of savings that are removed, you're able to get into it much faster. So I see two things happening. If you're in the middle of a rental crisis and a rental crisis is seeing your rents go up and up and up, it's proven as we analyze data that renters look at that rental crisis, see their budgets and just wonder how can I close the gap to one day owning that property or owning a property in the area where they're pretty much paying their landlord's mortgage. And so as a result, this will allow a barrier to be broken for many renters who want to get on the property buying market.

And this will be great news for first-time buyers for access to the power of real estate, wealth creation and permanent shelter. So what I think that does though is that the outcome of this is we will see a big push in affordable real estate or actually many brackets of real estate because this is a government cost matter. This isn't just for first-time buyers, right? Obviously, actually, sorry, it's for first-time buyers, but it's not for this very, very tight lower end bracket. The brackets will come up as more info comes up.

But I think the main thing here is that first-time buyers will have that support and lots of renters will transition to buyers. And as a result, that will push property prices up. So short-term, it opens up a big price wave of demand. Short to medium term, it opens up many transitioning opportunities for renters to home buyers. But like anything new, it then finds a space of equilibrium, meaning either A, prices have risen enough that whatever you saved in years of saving of stamp duty, it comes back into the price.

So exactly. So you're now going to put that towards a higher purchase price. Yeah, yeah, totally. So if you had a 400K property and you go, well, I now only have to save 40K for this, not 60 for stamp duty and that, one day that property's demand is going to be pushed up by many 40K seekers, the 40K cash seekers who are putting that in to 600K. And now that 400 becomes 600.

So for that 600 that you used to need 60K for when it was 400K, you now need that same 60K for it because it's now priced at 600K due to demand pushing it up. It's kind of like the whole train station, right? Oh, wow, train stations here, I really want to go into that suburb. Prices get set accordingly to what it offers. The train station becomes a forever amenity now, and now the prices are in line with that forever.

Same with schools, great school here, really love it. Okay, demand is there, but now the demand and the pricing of that properties in that school zone are always infinitely more expensive than the other, not necessarily growing better, but they've been factored in. So I do think there'll be a moment of factoring it in, then everyone goes back to paying what they were paying, and it was great for votes. So that land tax offer is available only for first home buyers buying homes within a 1. 5 million purchase price, which makes sense because like average house prices around 1.

5 now anyway, so that makes complete sense. Exactly, right? So I think the main thing here is that everyone's so used to saying the affordable is 4, 5, 600K, but with the way median prices have moved in major cities like Sydney, which make up a lot of transaction of New South Wales, even the one mil to 1. 4 is somewhat affordable to many Sydney siders. Yep, exactly.

The next thing here is property. So, so far we've gone through finance, some keynotes there, policy, and the third part is property. Yeah, okay. So the other thing is obviously what's on the property front, Arjun? So obviously a lot of things are happening in the property space and changes, and you wanted to go through some key things to be mindful of going forward, one of them being cashflow lag in property.

So what does that mean and what do you want to mention about that? Yeah, so as part of our six monthly review of what are the three core things people should be thinking about for the next six months ahead, the first one is cashflow lag in property. Why is that important? Right now, interest rates are moving at a faster rate the other direction. And so this means that the rental yields that people feel are needed to get the job done, there's two ways you can look at it.

You can expect either A, just less cashflow or a slight loss, or B, you can look at it and go, well, I want to target higher yields. And this is where people will run into some mistakes and they'll cut out many markets to look at for property investing.