What rising interest rates mean for property investors


Normally, the news that residential property prices are falling - meaning the market is starting to favour buyers ahead of sellers - would be met with a sigh of relief by those trying to buy their first home.

But fast rising interest rates, imposed by the Reserve Bank to curb galloping inflation, have thrown first home buyers a curve ball. Some will no longer be eligible for a mortgage and even if they do qualify many fear they won't be able to meet ever-rising mortgage payments.

This is not the case for investors. Under our current tax system, investors can claim a tax deduction for the interest they pay on mortgages on their investment properties. Indeed, negative gearing allows property investors who make a loss to reduce the tax they pay on other income.

investment property interest rates

Homeowners do not have the same luxury.

Rising interest rates will boost the cost of negative gearing tax concessions. So Australian taxpayers will pay billions of dollars so landlords can reduce their taxable income in coming years.

"We will see a substantial rise in the cost of negative gearing," says AMP economist Shane Oliver. "I wouldn't be surprised if we got to $5 billion to $6 billion per annum in net rental incomes."

Even better news for investors - although distressing for tenants - is that rentals are rising fast as demand for accommodation outstrips supply.

But before you jump into the market to either start or add to an investment portfolio, ask yourself if prices will fall further in the area you're interested in and by how much. If you wait too long you may miss the boat, as some analysts predict the fall will be short and sharp.

House prices are falling at their fastest pace since the GFC, and market conditions are "likely to worsen" as interest rates continue to rise, according to the property analytics firm CoreLogic.

The latest data shows that the nation's median property value has dropped by 2% since the beginning of May, to $747,182.

"Although the housing market is only three months into a decline ... the rate of decline is comparable with the onset of the global financial crisis in 2008 and the sharp downswing of the early 1980s," said CoreLogic's research director, Tim Lawless, in releasing the July statistics. 
In an interview with ABC News, he said: "I think this downturn will be similar to the global financial crisis in that it will be quite short and sharp."

Big cities hit hardest

Australia's median property price fell by around 8.5% over 11 months during the GFC, according to CoreLogic.

Many analysts predict residential property prices, on average, will fall between 10% and 20% (from peak to trough), with the two most expensive cities, Sydney and Melbourne, likely to suffer the biggest declines. Still, this would only partially reverse the 28.6% pandemic surge.

ANZ economists agree the downturn is likely to be shortlived. They predict house prices will fall by 18% over the rest of 2022 and 2023, but will turn around in 2024 and rise by 5% in that year.

Renters are also disadvantaged in the current property market, as rents have surged rapidly. The national average rent has jumped 2.8% in the past quarter and is up nearly 10% over the past year. To put this in context, it's very rare to see dwelling rents rising at more than, say, 3%-4% a year.

"Rental markets are extremely tight, with vacancy rates around 1% or lower across many parts of Australia," says Lawless. "The number of rental listings available nationally has dropped by a third compared to the five-year average, with no signs of a lift in rental supply. On top of already tight rental supply, it's likely demand will continue to increase as overseas arrival numbers climb."

Rising rentals are generally an incentive for investors to add to their holdings.

Some investors are also mindful that the tax breaks they enjoy may not last forever, but that any changes would not be retrospective.

While the new Labor federal government has ruled out any changes to negative gearing (which was its policy leading into the 2019 election), many commentators point out it disadvantages first home buyers.

A report from the Grattan Institute, a policy think tank, released a year before the May 2022 federal election, called for Australia's next government to put an end to one of the country's favourite tax breaks - negative gearing.

"The current CGT [capital gains tax] discount and negative gearing arrangements act to distort investment decisions, increase price volatility in property markets and put some upward pressure on house prices," says the report from the Grattan Institute's chief executive, Danielle Wood.

Another incentive for investors is that in spring they will have more choice as house and unit listings increase.

"A more substantial flow of advertised stock against a backdrop of falling demand is great news for active buyers, who will have more choice and less urgency," says Lawless. "Such tight rental markets, improving yields and stronger buying conditions should help to keep a floor under investment demand."

Get stories like this in our newsletters.

Related Stories

Unlike standard residential property, specialist disability accommodation benefits from a government-backed funding model to give investors a reliable income stream.

Money's founding editor Pam Walkley stepped down in early 2015 after more than 15 years at the helm. Before that she was at the Australian Financial Review for 11 years, holding several key roles including news editor, chief of staff and property editor. Pam is now a senior writer for Money.