How to navigate interest rates as a property investor

How to navigate interest rates as a property investor
How to navigate interest rates as a property investor

When interest rates go up, most homeowners react the same way - they take a big gulp! Conversely, when interest rates drop, these same people let out a big cheer.

Now, what about most property investors?  How do they react? You’re right, they react about the same.  Maybe they take a bigger gulp or let out a bigger cheer, but the reaction is generally the same. You see, for the property investor, the results are multiplied.  That can be good news or bad news.  If rates go up, then the “pain” is multiplied; hence a bigger gulp.  If rates go down, then the “joy” is multiplied, hence a bigger cheer.

What I’d like to do today is put some numbers to this “pain” and/or “joy.”  Take a look at how interest rates affect a property investor’s cash flow.

Property investor baseline situation

Let’s say our property investor has the following situation:

  • 5 rental properties
  • $200,000 mortgage on each property
  • Each property valued at say $350,000
  • 7% variable interest rate
  • Interest-only loan
  • $350 per week rental income

This should be enough information for us to make some cash flow calculations.

First, let’s calculate the weekly interest on these loans.

$200,000 X .07 = $14,000 / year

$14,000 / year X 1 year / 52 weeks = $269 / week per property

$269 / week X 5 properties = $1,345 / week

Now, let’s look at the rental margin.

$350 – $269 = $81 / week

$81 / week X 5 properties = $405

So, our investor has $405 per week left over after paying interest to the bank. Let’s estimate the other holding costs for each property.

Insurance, say $1,000 per year = $19 / week.

Property management = 10% of rent  = $350 X .10 = $35 / week

Taxes = $1,500 per year = $29 / week

Maintenance = allow 5% of rent = $350 X .05 = $18 / week

Now tally up all extra costs:

$19 + $35 + $29 +$18 = $101 per week

$101 / week X 5 properties = $505 / week

So, based on these estimates, our property investor is out of pocket each week; to the tune of $405 – $505 = $100 / week.

Not exciting.

Now, let’s run the numbers for two new cases. Let’s just assume a 0.5% change either way.

CASE 1:  INTEREST RATE RISE

If interest rates rise by 1/2 a percent (0.5%) then our property investor is in for some “belt-tightening.”

Weekly interest goes up to $1,442; that’s a $97 increase.

Assuming all the other numbers are the same, our property investor has just copped another $97 dollars in the negative each week. The cash flow has gone from negative $100 to negative $197.

Not exciting.

CASE 2: INTEREST RATE DROP

What if interest rates drop by a 1/2 percent? Let's say an interest rate of 6.5%.

Now our property investor will get some relief. The new weekly interest payment drops to $1,250 for the 5 properties. That’s a savings of $95 each week.

Again, assuming all the other numbers are the same, our property investor is now in a much better financial position. The shortfall each week is only $5.

Margin, Margin, Margin

Have you ever heard about the famous answer to the question, “What are the three most important aspects of property investment?" Remember the humorous answer, "Location, Location, Location"? Well, I’d like to follow that up with another question, “What are the three most important aspects of property investment finance?

And, my answer is, “Margin, Margin, Margin.”

I feel the property investor should factor in a safety margin to guard against interest rate rises. This can be in the form of fixing the rate low. Or it can be getting rents sufficiently high. Or reducing the debt owed. Or... (your creative idea goes here!)

As you can see from the numbers in this article, interest rates have a significant impact on cash-flow.  As property investors, we need to make sure we can survive the ebb and flow of interest rate tidal changes.

What safeguards do you have in place to mitigate the impact of an interest rate rise?

David Ives

David Ives

David wasn't born in Alice Springs but “he got there as soon as he could.” Husband, dad, author, property investor, camp fire guitarist and pick up basketball player.

Comments

Be the first one to comment on this article
What would you like to say about this project?