Low interest a double-edged sword

By ANNE GIBSON

The cost of borrowing eats into property investors' profits, but attractive interest rates mean investors can keep more of their share of the cake these days.

As the Reserve Bank eased off the official cash rate late last year, fixed rates continued to fall and got to the point where one bank was claiming it was offering its lowest mortgage rate in 40 years.

Last month, Reserve Bank Governor Don Brash left the official cash rate unchanged as expected (the rate directly affects floating mortgage rates).

Fixed rates also fell and on the back of the low interest rates, the Bank of New Zealand offered a special six-monthly introductory offer of 4.99 per cent - down from the previous 5.95 per cent offer - on home loans.

That was the lowest in more than 40 years, said Colin Mansbridge, the BNZ's head of mortgages.

"Bank research shows that the last time a bank offered a rate this low in New Zealand was in 1960.

"This is an outstanding opportunity for those people looking at getting into their first home, as well as those people wanting to refinance."

In its mortgage interest rate survey last month, the Real Estate Institute predicted that interest rates would be relatively stable this year.

It said floating interest rates were sinking, though it noted in December and last month that fixed rates were rising ever so slightly.

Most lending institutions had firmed the rate by between 0.2 and 0.5 percentage points in the month to January 10.

Institute president Rex Hadley said the year was shaping up to be a good one for borrowing for property.

"The increase in fixed rates has been relatively insignificant and seems to indicate the leading institutions are seeking to set rates at a more natural level than the recent historical lows.

"The institute does not expect rates to continue to increase throughout this year. The larger economic picture is that of a stabilising interest rate environment," Mr Hadley said.

But he warned those borrowing to buy real estate to be careful about the rates.

"Homeowners should be careful not to focus solely on trying to pick the absolute bottom of the interest rate market.

"While interest rates are obviously one of the key issues, it is vital that lenders chose a mortgage provider that also provides the best mortgage products and services," Mr Hadley said.

"Personally, I would be prepared to accept a slightly higher rate if that meant I could deal with a lending institution that was responsive to my needs and understood my financial situation. It's the whole package that counts."

Added to all this was good news from AMP's home affordability index, with results for December released on January 22. It found that houses are now more affordable than they have been in the past three years because wages are rising, interest rates are falling and house prices are stable. AMP Banking's operations manager, Noel Kirkwood, said people buying property would be doing so at a good time.

"Now is a great time to buy, given those three key factors of interest rates, wages and stable house prices," he said.

The home affordability index results for December showed the biggest improvement in three years and Graham Crews, a senior real estate lecturer at Massey University who prepared the survey, said the figures were particular strong, given that the Christmas month was normally quiet for property deals.

Gerald Rundle, manager of Bayleys Research in Auckland, has noted the opportunities this poses for buyers.

"The current low interest environment offers a number of opportunities and options for property investors," Mr Rundle said. "The current 90-day bill rate, as at early January, is below 5 per cent and not far off the very low levels recorded in late 1998 and early 1999 of around 4 per cent.

"We are experiencing the longest sustained period of low interest rates for many years. These historically low levels considerably enhance the returns from property to leveraged investors.

"Of particular significance to property investors is the difference between the income cash return from a commercial and industrial property and the cost of funding, typically measured by the 90-day bill rate plus a 2 per cent lending margin.

"This difference - often referred to as the yield gap - has widened quickly over the past 12 months in a positive direction on the back of falling interest rates," Mr Rundle said.

But Don Brash warned investors last month against loading up with debt with interest rates so low.

In fact, he said, that philosophy was putting our economy in peril.

The Reserve Bank's Governor's comments were not directed towards investors, but households highly-geared to own residential properties.

In a speech to the Canterbury Employers' Chamber of Commerce, Dr Brash lamented our poor savings record and the fact that most of our wealth is tied up in our property - invariably the family home.

Fifteen years ago the household saving rate was not too bad by developed country standards.

However, by 2000 New Zealand had slipped to the bottom of the OECD developed-country class.

By that year, our households were, in aggregate, spending more than their incomes.

"Unlike most developed countries, in New Zealand houses make up the overwhelming bulk of our relatively modest net wealth," Dr Brash said.

"Of course, we all have to live somewhere, but especially in a low inflation environment, houses do not offer a high investment return either to most of us as owner-occupiers or to those holding investment properties, although I acknowledge the incentives created by the present tax regime.

"New Zealand home ownership is no longer particularly high by developed world standards and, although getting consistent data over time is not easy, may even be slipping down the international rankings.

"I suspect this may surprise some people, as we tend to see ourselves as a nation of home-owners tending the quarter-acre plot.

"It isn't obvious that we are building a disproportionate number of houses either, but perhaps by default as much as by design we are rather too keen on having a house as the principal asset in our investment portfolios.

"What we haven't done is built up or maintained holdings of other income-earning assets,"Dr Brash said.

"Later this year, the Retirement Commissioner will release a report based on a fairly comprehensive survey of New Zealand household wealth.

"I suspect that underlying the aggregate figures - and by that I mean the household sector as a whole - some disturbing figures could emerge about just how low the wealth and savings of even the middle-aged middle income sections of our society are.

"What still isn't so clear is why we have cut our savings rate to such a low level.

"Part of it, of course, is simply that we could. In many developed countries following financial deregulation, households have run up debt levels quite substantially.

"Refinancing, and drawing down the equity in one's house, has become much easier with revolving mortgage facilities.

"Banks have, at times, marketed this opportunity aggressively. One innovative television advertisement encouraged home-owners to put the boat on the house, and illustrated the message by depicting a boat balanced on the roof of the house.

"The wisdom of following their advice literally, or financially, was for the householder to determine!

"But whatever the wisdom, households went on a borrowing spree.

"We estimate that household borrowing increased by $45 billion during the 1990s alone, from 57 per cent of disposable income in 1990 to 110 per cent in 2000, and that despite loud complaints from some about the high real interest rates on such borrowing," Dr Brash said.

"Perhaps a little paradoxically, lower inflation also facilitated the increase in debt," he said.

"Given the way mortgages are structured, lower inflation and the lower interest rates which come with it have allowed individuals to borrow more than they could in high inflation periods."

Low interest rates, it would appear, have become a double-edged sword.

NEXT WEEK - Gerald Rundle of Bayleys Research tells how investors can capitalise on low interest rates.

BNZ

Real Estate Institute on NZ

AMP Banking

Bayleys

Reserve Bank of NZ