For a number of years now, mortgage interest rates have been at historical lows in much of the Western world, in some cases at 40-year lows. The general consensus is that low rates mean low mortgage interest payments, and therefore higher affordability.
Many real estate investors determine what they can afford to buy, not on the basis of the deposit that would be required, but on what the monthly mortgage interest bill would be. For all these reasons, low interest rates may seem beneficial.
During periods of low inflation, we can reasonably expect interest rates to be low. Capital growth rates are often similarly low in these periods. Conversely, when inflation is high, prevailing interest rates and capital growth are often also high.
This brings me to an interesting observation. Back in the early 1990s, when the New Zealand government determined that inflation should be legally capped at 2%, many people made comments to me along the lines of “Dolf, with inflation capped at 2%, capital growth will be destroyed and there will be no more growth in real estate. So how can you go on promoting it as a good investment?”
The inference was that to do well out of real estate, people were dependent on capital growth. During periods of low inflation, significant capital growth would be reined in, making real estate a lousy investment.
There are many interesting aspects to this reasoning that we should consider.
High-Demand Property Commands Positive Cash Flow
Firstly, successful real estate investing is not dependent on capital growth. If you acquire sound real estate in areas for which there is good demand (be it residential, commercial, industrial, hospitality or specialist), then you should enjoy positive cash flow, and such income still beats exchanging time for money. If you are positively geared, then capital growth will be a bonus. But you will thrive even if there is no capital growth.
Secondly, low inflation does not always mean low capital growth for real estate. Not withstanding a low inflationary environment, a burgeoning population will result in demand inflation and capital growth. A case in point would be New Zealand where, despite a decade of relatively low inflation, capital growth has surged ahead through demand inflation. Another example would be Germany, where real estate values have increased even during periods of negative inflation (deflation).
Thirdly, and most interestingly, is the bias that many professions have against real estate. Many seize on the opportunity to infer that when inflation is capped, there will be no growth in property values, therefore real estate will no longer be a good investment.
Now that inflation rates are widely predicted to rise, these same pundits are saying that real estate will no longer be as good an investment as it has been in the past, as affordability decreases and capital growth disappears.
In other words, when inflation is high (remember this tends to go hand-in-hand with high interest rates and high capital growth) but set to come down, the commentators suggest that real estate will no longer be a good investment. And when interest rates are low (remember this tends to go hand-in-hand with low inflation and low capital growth) but predicted to rise, the commentators are suggest that real estate will no longer be a good investment.
Whichever Way the Market Goes
The reality is that whether interest rates are high or low, you can do exceedingly well as a property investor. When interest rates are high, there tends to be high capital growth. Conversely, when interest rates are low, you have the opportunity to lock in these rates, thereby guaranteeing low mortgage outgoings for as long as you can fix the interest rates.
The truth is that I do not really care whether interest rates are on the rise or on a high. I know we will have some delightful capital growth. I will have some great buying opportunities as many people bail out of real estate. When they are falling or low, I know that I can finance properties using lower interest rates.
Don’t spend too much time analysing the economy. There is such a thing as paralysis by analysis.
With sufficient financial intelligence, you can gain the confidence to do well in real estate.