A new report has revealed the surprisingly low ‘break-even’ capital gain required to generate a decent post-tax investment return in the current market.
The Australian Mortgage Industry Report released by J.P. Morgan last month has revealed that the housing market only needs modest growth to generate strong returns.
According to J.P. Morgan banking analyst Scott Manning, the capital gain required to incentivise investors to keep participating in the property market is “not as high as you would actually think”.
“The main reason is that the amount that you borrow on an investment loan is a fraction of the total investment property’s value. That debt is fixed in nominal terms. What you then have is an asset that is bigger than that and growing in real terms over time,” he said.
“Even if you’re only looking at capital growth in the order of 1.5 to 2 per cent per year, relative to the 5 to 7 per cent that we’ve seen historically, you are still going to get post-tax IRR of around 5 per cent.
“That is a post-tax return over the life of the investment of around 5 per cent, and that is still very attractive relative to a pre-tax return on a deposit at the moment of around 3 per cent, for example. Property is still seen as a better return prospect than deposits, even as people are expecting house price appreciation to not be as strong in the future.”
Mr Manning’s comments point to a silver lining in what has become an otherwise bleak outlook for Australian residential property investors.
A report by Moody’s Investors Service released earlier this week warned that the affordability of servicing investment properties is now at its worst levels on record, and that investors could be at risk of mortgage default.
According to the report, the affordability of residential investment property – defined as the net cost of servicing a residential property investment as a percentage of net household income – is at the worst level on record for investments in houses in Sydney and houses and apartments in Melbourne.
Moody’s calculated that investors in Sydney houses require 39.6 per cent of net household income to service their investment properties, while Melbourne house investors require 26.5 per cent – both record highs.
“The deterioration in the affordability of servicing investment properties makes residential property investors more vulnerable to risks such as loss of income, interest rate increases, vacancies or rent reductions,” it said.
“The decline in the affordability of servicing investment properties also reduces investors’ flexibility around refinancing or restructuring their mortgage loan terms, giving them less options should they experience hardship and therefore increasing their likelihood of default.”