The anticipated economic fall-out from the coronavirus will likely cause structural change in many industries. Property investment will not be exempt.

However, over the medium-term, property investment will likely become more attractive to the average Kiwi. Why? Because lower and lower interest rates make some asset types more profitable and others less lucrative.

As interest rates decrease, keeping cash in a term deposit becomes less attractive. In contrast, leveraged income producing assets become more profitable.

Let’s Dig Into The Numbers

In mid-March, the Reserve Bank of New Zealand cut the official cash from 1.0% to 0.25%. That’s a massive 75% cut. Two days later, ANZ cut their one-year fixed interest rate on lending to 3.05% and decreased their one-year deposit rate from 2.6% to 2.35%.

Not satisfied with the level of cuts, the Reserve Bank has announced Large Scale Asset Purchases. This unconventional monetary policy will see interest rates fall further.

Even before interest rates fall further, yield investors will suddenly find leveraged property higher yielding than term deposits. Let’s look at the numbers before and after the interest rate cuts.

Before The Interest Rate Cuts

Before Monday March 16, the four Australian banks’ term deposit rates ranged between 2.0-2.6%, ANZ being the most generous at 2.6%.

If an investor put $100,000 into a term deposit, within 12 months, they will have made $2,600.

Let’s compare that to what the same investor could yield through property. Take the example of a brand new property, which is on the market for $500,000 and will rent for $495 per week.

This property would have annual revenue of $24,255, once taking off three weeks’ rent to account for vacancy (not having a tenant for three weeks of the year).

There will likely be $8,957.83 of operational costs, like maintenance, accounting, rates and insurance. Then, once you account for the interest payments on a $400,000 mortgage at 3.45% interest rates (since there is a $100,000 deposit), you are left with a cash surplus of $1,497 per year for the property.

That means investors could get a better cash return on their deposit by leaving the money in the bank. Term deposits would yield 2.6% and property 1.5%.

Of course, a property would achieve long term growth in its value. Still, in this scenario, we’re just looking at the cash return on the investor’s deposit to weigh up how interest rates will likely impact behaviour.

Post Interest Rate Cuts

Now, let’s look at how the interest rate cuts have changed the investor’s incentives. The cut in the term deposit rate decreases the return this investor can get from savings to 2.35%.

The most significant impact to our comparison comes from the fall in the one year mortgage rate from 3.45% to 3.05%. That 0.4% decrease, though small, is the equivalent of a 1.6% increase in net yield through property. Why? Because the cost of mortgage repayments fall from $13,800 to $12,180, saving the
investor $1,620 on finance.

All other costs stay the same, which means that instead of netting $1,497 annually, the investor gets $3,117 from the property in cash. Based on the initial $100,000 deposit, the investor can, therefore, get a 3.1% cash return on their deposit through property.

So the investor’s options in this example are a 2.35% return from term deposits or 3.1% from property, while still getting long term growth in the value of the property.

I don’t mean to diminish the impact of coronavirus. After all, I am writing this column from home during the lockdown. But, the changes in interest rates fundamentally change the asset types that produce higher returns for investors.

Because of that, I’m expecting the average Kiwi investor will become more interested in property investment over the medium term.