Growth Over Yield.

Over the last few weeks we’ve started to hear more and more about the tightening of credit conditions.

Recently, The Australian Prudential Regulation Authority has written to banks telling them to increase the buffer rate by 0.5 percentage points, from 2.5 per cent to 3 per cent by October 31.

What is happening here is that when lenders assess your ability to borrow, they will now assume that the interest rate you’re going to be paying is higher than the one currently available. 

What this indicates is that at some point in the future, the RBA will increase interest rates and that will mean getting a home loan, or more correctly the amount of money you can borrow will be a bit tighter than what it is now.

While interest rates moving higher isn’t necessarily bad, in that it indicates the property market and overall economy are strong, it will change the dynamic for many property investors.

In recent times, we’ve been hearing a lot about positively geared properties and how this type of strategy allows you to build a very large property portfolio. These steps in tightening credit, make it a lot harder to build a large portfolio by using a strategy that focuses predominately on the yeild side of the equation. If there are caps on debt-to-equity ratios and large serviceability buffers, then these cash flow type strategies become more difficult.

From a practical perspective, we already know that lenders will only assess 70% of your rental income, to begin with. Unless, rental yields keep pace with these rises in interest rates and buffer rates, then positively geared properties can quickly become neutral or even negatively geared. If they are not in locations that are seeing that strong growth, then there can be issues moving forward and trying to grow that portfolio.

On the flip side, if your strategy has always been to focus on buying high-quality assets that generally grow at high rates, but might be slightly negatively geared, then there will be less of an impact on your strategy going forward.

In an environment with rising interest rates and buffer rates, a positive cash flow strategy can potentially fall flat. Whereas growth in blue-chip areas has traditionally occurred throughout different market cycles, with these areas only experiencing limited periods of price corrections.

If your assets are still growing and you have a solid income, then you will still be able to access any spare equity and keep moving your portfolio forward.

If you give up that growth in search or yield, that could be tougher in a changing credit environment.

The benefits of seeking growth over yield will likely become more evident in the months and years ahead.