Why do interest rates rise?

Last week the Reserve Bank of New Zealand (RBNZ) decided to raise the official cash rate (OCR) by a further 50 basis points (0.5%) to 3.5%. This was the 8th raise in the past 12 months. The reason they do this is because they are required to control the level of inflation in New Zealand to within one and three percent. Increasing the OCR (the wholesale rate for lending money) is one mechanism they have for controlling inflation. An increase in the OCR directly impacts the interest rates that banks charge their retail customers i.e. mortgage holders because

For a better definition and more comprehensive explanation of the OCR see The official cash rate explained - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz)

How does rising interest rates affect mortgage payments?

An increase in the bank interest rates filters into the market slowly. For property investors who have fixed rates for a period then things won’t change until their fixed term ends. For others that are on variable rates or those just coming off fixed rates then they will see their mortgage repayments increase. Over the next 1-5 years everyone will see the interest payments on their mortgages increase.

Although, the current rates may seem high in relation to recent history when we look back beyond the past 20 years, we see that these rates are still low compared to the rates of the 70s and 80s. The good news is that the current monetary policy will never allow rates to increase to the high teens and early twenties that were seen back in those times. The bad news is that we could see further increases in the next 12-24 months.

How does this impact my investment property?

The immediate effect of increasing interest rates is to make investing in property more expensive. This should (in theory) reduce the demand for property and place downward pressure on prices. This in turn attracts buyers back into the market as they begin seeing value in the lower prices. This cycle may take 2 or 3 years followed by a period of consolidation and a further period of growth.

For existing property portfolios it can mean a valuation drop and a decrease in equity. It can also mean tighter cashflow with lower profits for some and greater negative cashflow for others. When you factor these impacts on cashflow with the changes to interest deductibility then some investors may see significant cash deficits for the coming few years.

This may force some investors to sell some properties to consolidate their cash position. Others who have perhaps have been taking a more conservative approach will benefit and may even look to expand their porfolio by adding some good value properties.

How will this impact the Dunedin rental market?

The demand for rentals in Dunedin is forecast to be strong for the next few years. This is largely off the back of major infrastructure projects going on in the city as well as the return of tourism. Although, property sales may be lagging right now the rental demand is very strong and early in this summer season. Rental prices are continuing to rise. For Dunedin property investors this will be a nice offset to increased mortgage payments.

About the Author

Rueben Skipper is the founder of Dunedin Property Management and an experienced businessman and property investor.