The Cup Day decision from the Reserve Bank ran to form: the cash rate remains the same, meaning official interest rates have been at 2.5 per cent since August last year and standard variable mortgages can be had for less than 5 per cent.
Nothing unexpected from the RBA, but there was a remark in the Governor’s statement which sums up what is going on right now. “Investors continue to look for higher returns in response to low rates on safe instruments.” In other words Australians are doing what they should, and they are looking for ways in which their cash can perform better.
If you accept that the “safe instruments” are cash deposits and term deposits, which attract the government guarantee but yield between 3 and 4.2 per cent, you can see why motivated investors are looking for higher returns. Earning one per cent more than inflation is not a strong investment strategy in most people’s books.
In this environment, people are stepping up to slightly higher risk levels but with better returns. Bonds are a natural progression from cash, usually accessed through “fixed interest” fund managers. They are very stable and return somewhere between cash deposits and major ASX indices, depending on the mix of cash, government bonds and corporate bonds.
Another avenue – and slightly riskier than bonds – has been the “yielder” stocks on the ASX. These include shares in the big banks, Telstra and the big miners, and yield dividends of between 5 and 6 per cent while also giving some capital growth.
But the investment gaining attention is the purchasing of rental properties. Essentially, investors can use low-cost mortgages to buy rentable assets that return annually up to 9 per cent (rent and capital growth combined). If the rental income doesn’t cover costs, the property can be negatively geared.
The investment property market has been strong: the total income of Sydney rental property in the year to June 2014 was 20.2 per cent. Melbourne was 12 per cent. Of course, you should average your total returns over 5 or 10 years to get a sensible return, but this spike has made a lot of commentators nervous about a property ‘bubble’, fuelled by low interest rates and negative gearing.
I’m not convinced there’s a big problem. For a start, as I’ve mentioned above, when interest rates are low for a long time, investors have to make their money work: that’s their job. Secondly, the RBA has mentioned investment property in its last few statements, without raising alarm. It has even acknowledged that people are looking for better returns than cash.
Finally, the RBA is aware of the banks’ mortgage data, and has good insight into the quality of Australian home lending. No property market is a foregone conclusion; prices go up and down as do rental yields. But for now, the cash rate is in the right place for inflation and growth, and investors are responding exactly as you’d expect.