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Where highly leveraged property investors of property located in Auckland could get caught out.
Property investors may or may not be financially literate people.
Even if they are financially literate people, some of their initial assumptions may subsequently prove to be incorrect, some may not have allowed for sufficient financial flexibility in their calculations for unexpected costs / outgoings. Here are some assumptions that may have been made at the time of purchase and may subsequently proved to be incorrect, thereby potentially putting them under some financial stress:
1) unexpected cost of healthy homes bill to provide insulation - especially investors who purchased their property before this was even being discussed in parliament, or raised by politicians
2) overly optimistic assumptions of rental increases in the future
3) property prices doubling every 10 years
4) negative gearing for property investors to continue indefinitely
and the key one -
5) assuming that the interest only mortgage used to finance the purchase can be rolled into another one at the end of the interest only period and kept on an interest only basis indefinitely.
This is possible for borrowers classified by banks as business borrowers and commercial borrowers (who are subject to different loan covenants), but a potentially faulty and financially fatal assumption for borrowers where banks have classified them as a consumer borrower. Many property investors who own 1-3 investment properties are likely to be classified as a consumer borrowers by banks, and may be unable to meet the banks more recent stringent credit criteria (such as 7-8% stress interest rate payments on a P&I basis) and then be unable to refinance with the bank on an interest only basis. As a result, there are a number of consumer borrowers refinancing and moving their borrowing to non bank lenders.
Remember that the non bank lenders have a much smaller lending capacity in total than the banks (and hence can only refinance a limited number of borrowers), so what happens when a consumer borrower with a loan from a bank on interest only mortgage terms is unable to refinance with a non bank lender? If this property investor is unable to make the higher P&I payments to the bank (or has to drastically cut back on their personal lifestyle to make those higher payments), what will that property investor do then?
Then the follow up question is, what if there are a large number of these consumer property investors experiencing this at the same time? Or there is an economic recession or global economic shock?
I recently read about a investor who owned a property investment in Auckland - they purchased the property in early 2016, using 100% finance on an interest only basis (using those 'equity release' / ' deposit recycling' financing strategies that some property mentors were recommending). They were negatively geared, and it was costing them about $100 per week as the interest cost more than absorbed all the net rentals (after operating costs such as rates, insurance). Their loan was becoming a P&I loan where the total cash that they would need to pay to maintain ownership of the property would increase from $100 per week to $350 per week. They were talking about changing their lifestyle to cut costs or they were considering selling. How many other property investors are in a similar situation? If there are many, that could result in a demand / supply imbalance in the property market.
Property investors may or may not be financially literate people.
Even if they are financially literate people, some of their initial assumptions may subsequently prove to be incorrect, some may not have allowed for sufficient financial flexibility in their calculations for unexpected costs / outgoings. Here are some assumptions that may have been made at the time of purchase and may subsequently proved to be incorrect, thereby potentially putting them under some financial stress:
1) unexpected cost of healthy homes bill to provide insulation - especially investors who purchased their property before this was even being discussed in parliament, or raised by politicians
2) overly optimistic assumptions of rental increases in the future
3) property prices doubling every 10 years
4) negative gearing for property investors to continue indefinitely
and the key one -
5) assuming that the interest only mortgage used to finance the purchase can be rolled into another one at the end of the interest only period and kept on an interest only basis indefinitely.
This is possible for borrowers classified by banks as business borrowers and commercial borrowers (who are subject to different loan covenants), but a potentially faulty and financially fatal assumption for borrowers where banks have classified them as a consumer borrower. Many property investors who own 1-3 investment properties are likely to be classified as a consumer borrowers by banks, and may be unable to meet the banks more recent stringent credit criteria (such as 7-8% stress interest rate payments on a P&I basis) and then be unable to refinance with the bank on an interest only basis. As a result, there are a number of consumer borrowers refinancing and moving their borrowing to non bank lenders.
Remember that the non bank lenders have a much smaller lending capacity in total than the banks (and hence can only refinance a limited number of borrowers), so what happens when a consumer borrower with a loan from a bank on interest only mortgage terms is unable to refinance with a non bank lender? If this property investor is unable to make the higher P&I payments to the bank (or has to drastically cut back on their personal lifestyle to make those higher payments), what will that property investor do then?
Then the follow up question is, what if there are a large number of these consumer property investors experiencing this at the same time? Or there is an economic recession or global economic shock?
I recently read about a investor who owned a property investment in Auckland - they purchased the property in early 2016, using 100% finance on an interest only basis (using those 'equity release' / ' deposit recycling' financing strategies that some property mentors were recommending). They were negatively geared, and it was costing them about $100 per week as the interest cost more than absorbed all the net rentals (after operating costs such as rates, insurance). Their loan was becoming a P&I loan where the total cash that they would need to pay to maintain ownership of the property would increase from $100 per week to $350 per week. They were talking about changing their lifestyle to cut costs or they were considering selling. How many other property investors are in a similar situation? If there are many, that could result in a demand / supply imbalance in the property market.
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