Interest Rate Tipping Point How commercial and Residential Compare

The pattern for someone investing in property is that they get told by their accountant to buy negatively geared property to offset their tax.

All good – they find a home they can afford, get some renters in and enjoy getting a little of their tax.

After a while, the value of the property goes up a bit, and their accountant tells them to refinance and do it again…

That's when the trouble starts.

They get the idea that more is better and they want to go again… but the banks won't lend them more.

They reach their lending limit.

Smarter investors work with cash flow neutral or positive properties… they look for deals that make them more money than it costs to own.

The banks like that better.

But it's a very rare property indeed that will produce much more than 5% returns meaning that while they might be able to call the property cash flow positive…

It's not generating enough cash flow to actually make that investment meaningful.

An extra 3 or 4 grand a year is not going to allow you to go nuts buying property.

Typically the banks will still find a limit to their lending for this type of investor.

Banks just won't want to be too exposed to a single investor when their properties are only producing a small amount of positive cash flow.

The reason comes down to legislation and interest rates.

If you're so close to neutral that a decent change in interest could throw the whole investment into the negative, then they are going to have an issue with it.

So let me show you why I never worry about lending limits.

In three simple words:

Significant cash flow.

Choosing the right commercial property will create enough cash flow that it will insulate you from interest rate rises.

Of course, it's true that a significant interest rate rise will hurt your cash flow, it won't break you.

Not only that, but rent rises are built into the lease… usually these are set at a specific yearly increase with a caveat… that being the stated increase rate or in line with CPI whichever is higher.

That means that if the treasurer, for whatever reason decides to jack up interest rates… you may take a pay cut for a bit… but it will rectify itself at the next rent review.

But that's not the end of the story…

If you own residential rental investment property and the interest rates go up… you will be able to negotiate some rental increase…

But chances are you may not be able to stay in line with inflation as individuals are a lot more sensitive to rental increases…

You may try to put the rent up and only achieve having a vacant property for a time.

But that's an aside.

The really interesting thing is this:

Interest rates go up…

Rent review comes along…

You put your tenant's rent up to stay in line with CPI

Let's say it goes up more than expected because you weren't anticipating the rate rise…

That's all good… but guess what else happens?

The value of your commercial property is tied to the rent…

So if the rent goes up more than expected… that also shows up as added value… your commercial property is suddenly worth more.

So, while you may take a pay cut for a little while if there was a significant rate rise, you'd most likely make that money back in the long run in added equity.

While residential investors are freaking out and wondering what to do with their far less positive or even negative properties… post rate rise…

You're chilling on a beach slurping a coldie and watching your equity increase.

I know where I'd rather be.