BLOG BY PHIL KELLIHER.
Just two years ago the housing market was in a frenzy, with properties going for silly money.
But now it’s the opposite. For property manager Phil Kelliher, this was vividly illustrated when he noticed a large property in Mt Victoria listed for nearly one million dollars less than its RV.
A recent listing of a house open to hearing offers nearly $1 million under rateable value (RV) caught my attention.
Two years ago – in the middle of the housing boom - a place like this would have been snapped up. Have things changed so much for property investors? I decided to run some numbers.
Two key factors have influenced the affordability of property since then. Firstly, and most significantly, we have seen a steep rise in interest rates.
Secondly, for investors changes in tax deductibility rules are underway. The tax deductibility of interest is moving from 100% deductibility pre 1 October 2021 to 0% post 1 April 2025.
My analysis looked at three scenarios:
- The situation in October 2021 where the property would probably have sold for at least $2 million, but interest rates were only 2.5%, and the cost of interest was fully tax deductible.
- The situation now, where the property is being offered at $1.25m, but interest rates are 7% and only 50% of the interest costs are tax deductible.
- The situation in 2025, assuming the sale price and interest rates stay the same, but none of the interest costs are tax deductible.
To make it simple, I have assumed it is fully debt funded, and I looked at the likely rental income you would get based on today’s market. My analysis included the usual maintenance, insurance and rates costs, and worked out the profit or loss you would make annually.
The results of my analysis are below.
|Context||Assumed sale price||Annual return|
Pre October 2021 - Interest rates 2.5%, cost of interest is fully tax deductible.
Post 1 April 2023 - Interest rates 7.0%, cost of interest is 50% tax deductible
Post 1 April 2025 - Interest rates 7.0%, cost of interest is 0% tax deductible
Despite the much higher price in October 2021, the property would have pretty much broken even, because of the low interest rates and ability to deduct interest costs.
But the same property today would make a substantial loss of around $43,000 each year - even with a massive price reduction. Looking to the future, after 1 April 2025 where the tax deductibility is removed completely shows the loss increasing to over $55,000.
In fact, to make this property break even in a fully debt funded scenario post the full removal of interest deductibility from 1 April 2025, assuming nothing else changes, the property price would have to fall to around $500,000!
This shows the huge impact on affordability caused by the unprecedented rise in interest rates combining with the removal of interest deductibility.
Of course, this scenario is based on the property being fully debt funded – investors or future homeowners with a big deposit may find this property a more attractive prospect. I have done this calculation simply to illustrate the dramatic difference that has occurred for leveraged investors (which is most investors) over this short period of time.
It also points to the reason why that market frenzy occurred in 2021 – low interest rates made even expensive properties ‘affordable’ - and the removal of the deductibility of interest for investors is a big deal!