Monthly Archives: October 2021

Buying, Cost of debt, Financing, Property prices

The cost of debt and impact on property prices

Leave a comment
As interest rates go down, property prices go up

The cost of debt… it sounds like a philosophical question or an attention-grabbing headline on the detrimental cost to society of Millennials living their lives on credit cards and buying too much avocado toast. What I simply mean is “what does it cost to borrow money”? You can borrow money for a variety of reasons however I am referring specifically in this article to borrowing to buy a property, aka getting a mortgage, and how cheap debt pushes property prices up.

If you speak to your bank, a mortgage broker or even type into google “mortgage rate” you’ll be inundated with offerings hovering around 1.8 to 2.2% (October 2021). These are annual percentage rates and simply put, if you had a mortgage rate of 2% you would be paying $20,000 per year on a $1million loan. But where does this magical 2% rate come from and is that high or low?

Mortgage rates were highest at 17% in January 1990

To answer the last question first, current mortgage rates are the lowest they’ve ever been. In January 1990 you could have been paying 17% for your mortgage and rates have never really been lower than 5 or 6% even during the Global Financial Crisis in 2008. So, why and how are mortgage rates so low right now? Which leads me back to the first question of how is the rate set?

All interest rates, whether earned on money deposited in a savings account or conversely paid on money borrowed to buy a house, are set off the Reserve Bank of Australia’s (RBA’s) cash rate plus a number of other factors (see previous post here). The RBA announces the new cash rate on the first Tuesday of every month (except January) and weighs a number of economic factors such as unemployment and inflation to determine the rate. The RBA can use the cash rate to influence borrowing or saving to help stabilise the economy.

Currently the RBA cash rate is 0.10%, the lowest it has ever been and almost zero.

If the RBA wants to encourage borrowing the cash rate will be lowered (you pay less interest) and if they want to encourage saving the cash rate will be increased (you earn more interest). Put another way, if the RBA wants people to borrow more they will make it cheaper and easier to do so. But why would the RBA want people to take on more debt?

During the global Covid pandemic with millions of people dying worldwide, billions being locked down for extended periods of time and countless businesses having to temporarily close and potentially going bust, the hit to the global economy has been huge. The Australian economy has been affected by Covid in many ways.

Total unemployment has soared from 5.1% to 7.4% in a five month period

The total unemployment rate has drastically increased from 5.1% just before Covid hit in Feb 2020 to 7.4% in July 2020.

Inflation has sky rocketed in 2021, a direct result of the global pandemic

Furthermore, inflation has gone from around 0% annual inflation in the year ending 2019 to almost 4% in 2020. An increase in inflation is generally a good thing but means the cost of living has increased and the rate at which it has increased during this time is significant. So, less people are employed and it costs more to live. Because of this and many other factors, the RBA is trying to stimulate the economy to spend. And the more we spend the more we borrow.

Therefore, currently you could say the cost of debt is cheap. It does not cost as much as it has done historically (or ever!) to borrow money, and because it is cheap, we can borrow more. For instance, in 2014 the average interest rate was 6%, which on a $1million loan would cost you $60,000 per year. Lending institutions calculate your loan size based on income, current spending habits and a number of other factors. If none of these factors have changed but the interest rate has dropped, because you used to be able to afford $60,000 p.a. on $1million but now it only costs $20,000, the bank is happy to lend you more because you can service a higher level of debt on a lower rate.

And this finally leads me to explain how being able to borrow more money means that buyers can pay more when buying property, which is driving property prices up. If you could only borrow $1million before and a house at auction goes past this point you would have been out. But now you can borrow $1.2million you still have more spending power to stay in the auction. It doesn’t really matter what the property is worth (up to a certain perceived value point), if there are two or more interested buyers with money to spend still interested in buying the property, the price will be set just higher than the lowest bidder’s limit.

The RBA and the government do not want to create a property bubble, nor push prices up any further but these unprecedented times cause for drastic action. Which takes me back to the Millennials at the start of this article and the economic conundrum of housing affordability for the younger generations. Should they stop eating avocado toast and save more, or should the government intervene with drastic changes to the property industry (via duties, taxes, incentives and disincentives)? Or will it be left up to the mums and dads to personally redistribute generational wealth?

Uncategorized

Lockdown and virtual property auctions

Leave a comment

Covid lockdowns have brought many unforeseen changes to the way we live our normal day to day lives. In person property auctions are prohibited and virtual auctions are the temporary norm. The property industry has had to pivot and find a new way to conduct business, especially during the current property boom.

You may ask, why would anyone want to buy or sell property during the pandemic and especially during lockdown, but life must go on. You may have listed a property then the city goes into lockdown, another baby on the way makes the need for more space time critical, or you may just be sick of living, working and exercising in the same home every day because of lockdown and need a change. The resilience and perseverance of many businesses and society to keep moving forward and living life as best as we can during Covid is inspiring.

Properties can be sold (called private treaty) or auctioned in Australia but where the area or property is in high demand it usually goes to auction. Certainly, in inner city Sydney, which is a very competitive property market, most properties will go to auction, and across Australia approximately one quarter of properties are sold via auction.

I attended countless auctions when I was trying to buy a property over 12 years ago in Sydney. There were massive turnouts, usually standing in front of the property in the street or squeezed inside the living room, with every inquisitive neighbour and passer-by also attending. The bidding was competitive and intimidating, and everyone had eyes on the potential buyers vying for a chance to secure the property before they reached their absolute (top top, maybe just a tad more!) maximum spending limit. I tried to buy at a few auctions when I thought I had a chance but was always outbid, eventually thankfully buying by private treaty.

The start of a virtual property auction with the auctioneer presenting and the bidding activity read to start below

At a virtual auction you are sitting in front of a computer looking at a live video of the auctioneer and underneath are are the live bids including the Bid, Bid Amount and Bidder (identified only by a number), with the latest bid at the top. You don’t know who the other bidders are, what they look like, are they old or young, are they single, couple, family, downsizers, and most importantly do they look like they have more money than me…? And bidders only participate by submitting a bid electronically, there is no noise aside from the auctioneer’s voice, who operates in much the same way as at an in-person auction.

Buyers who are interested in attending a virtual auction must electronically pre-register. This provides an interesting indicator in the lead up to an auction of how many buyers are seriously interested, whereas at an in-person auction you only need to register when you arrive. Of course, a registered bidder might not log in on the day, nor even place a bid, but 2-3 registered bidders is a good number, 6-8 is great and anything above that is excellent. This is vastly different from some in-person auctions I attended with literally 60-70 spectators and who knows how many bidders.

I had my reservations of the process, and as a seller was seeking the atmosphere and buzz from an in-person auction, hoping that would spur on the competition. However, my agent, who was absolutely amazing and patiently held my hand (figuratively of course, social distancing rules apply!) throughout the whole campaign, explained the unexpected benefits of this new process.

All in-person auctions would usually be scheduled on a Saturday but because everyone is at home sitting in front of a computer in lockdown, virtual auctions can be held any day of the week (usually Wednesdays to Saturdays) and interest for mid-week auctions versus the traditional Saturday is much higher. There is a captive audience just waiting for something exciting to do during their lockdown day.

Sometimes in a fierce bidding war it’s hard to hear and keep up with the bid and who is still bidding but the history of bids on the screen in front of you makes it very neat and organised. You can clearly see which bidders are currently participating, which may have dropped out and who is bidding in large jumps to tactically scare other buyers away. Adding a timestamp to the bids would be useful to track the flurries and pauses. It also saves a poor junior agent, just starting their career, having to frantically jot down these bids on a notepad as they are made.

While I prefer to see and size up my competition, some buyers may welcome the anonymity and controlled environment of a virtual auction. Tech savvy buyers in the younger generations are completely comfortable with virtual auctions. However there has been reservation from the older generations and on occasion these buyers request agents bid on their behalf or perhaps shy away from the process.

During an in-person auction I had always noticed the agents sidling up to bidders and whispering in their ear, trying to gauge their interest, encourage bidding and squeeze every last cent. I wondered how this would work in a virtual auction but agents are usually on text or phone call with the bidders (and seller) throughout the process so this line of communication is potentially enhanced while open conversations can be held in private. Bidders can simply not answer the phone or texts however, so this is not entirely fool-proof.

In terms of the feared lack of buzz I was very wrong. With the sole focus on those bids climbing up, with nothing but your budget and the latest bid in front of you, the process hones focus to the auctioneer and the number at the top of the list. If enough serious bidders attend (you only need two keen ones!) this alchemy creates some very fierce competition. As a buyer I would say your usual auction strategy is still very much applicable for a virtual auction – know your budget and be confident.

I asked my agent if virtual auctions will continue after lockdown life given their success but he predicts not. There is just nothing quite like the experience of an in-person auction. I wonder if auction apps will be designed to facilitate digital pre-registration and bidding during future in-person auctions, mixing elements of all methods and bringing the auction process into the digital age.