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Investment Property - Part 2
Mortgage and Interest Rates
In order for there to be a vibrant property investment market, mortgages need to be freely available. The relationship between interest rates and investment property prices is a crucial one. As interest rates go up, mortgage repayments increase. If rents stay the same, the gap between the cost of borrowing and maintaining the property and the rent received, can quickly go from positive to negative. A property which started off covering all its costs, and even showing a profit on the rent, called ‘washing its face’, can suddenly start costing money.
In the UK market this has already happened in recent years and properties that wash their face on high percentage mortgages have become more difficult to find. As a result, it has become necessary to put down a bigger and bigger deposit to avoid subsidising the mortgage from your own pocket. Of course the larger the deposit, the greater the opportunity cost of the interest lost, added to which not everyone has access to large deposits in the first place.
There is however a relationship between property prices, mortgage rates and rents. As prices go up, more people are priced out of the market and have to rent. If more people are looking to rent, this has the effect of pushing up rents, an effect which is amplified if interest rates go up and less people buy property and become landlords. The net effect is that by providing a pressure relief valve for the market, generally, tenants allow prices to equalise around supply and demand criteria, without the huge speculative boom and bust cycles we have seen in the past.
Avoid the Hype
Of course when we speak of the property market in the UK, what we are really referring to is a vast collection of local markets, some of which will be going up while the majority are going down and vice versa. It is vital to do the right research, evaluation and analysis before deciding where to buy. As another warning, this is not always in your back yard!
In recent years, there has been a general equalisation of property prices between the South East and other areas of the country. This has happened primarily because incomes have tended to converge over the past few years and there have been massive improvements to infrastructure in underdeveloped areas. So these increases in price cannot be seen as unrealistic, or as signs of a speculative boom, they are merely reflections of changes to the real state of the market.
This cannot be said for all increases. One of the biggest changes that has taken place in recent years, has been the emphasis placed on the regeneration of major city centres like Manchester and Liverpool. While this re-generation has been a generally good thing, leading to more jobs, a better environment and more wealth, it has also led to some frothy speculation in upmarket apartment developments sold off plan. In many cases the valuations used to sell these developments at the off plan stage, have turned out to be wildly optimistic, as have the rental projections. In addition creative discounting was also often used in order to boost buy to let mortgages. In some cases this resulted in mortgage in excess of 100% of the real purchase price, making the properties unviable when they were completed and leading to huge headline falls in price.
Although these price falls may look spectacular, it has to remembered that the original valuations were widely optimistic, only now these developments are coming to completion can the actual real values be established. You should not allow these types of situations to blind you to the fundamentals of the property market, which generally remains healthy and stable. It may even be possible to pick up a property in one of these developments at the correct price, as adjusted and to end up with a great investment after all as rental demand catches up with supply.