How will COVID-19 affect investing in Rental Apartments?

Investors who buy rental apartments that are unsuitable for families are taking a gamble, with both equity and cash flow risk expected to materially increase, according to RiskWise Property Research CEO, Doron Peleg.

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COVID-19 has undoubtedly had an impact on the property market, but investors with rental apartments in their portfolio may be feeling the hit hardest.

What is the current situation?

The Federal Government has announced a six-month moratorium on rental evictions. The states and territories also set measures to support tenants. For example, Tasmania has brought in a law that suspends evictions for any reason for 120 days. In NSW, the COVID-19 Legislation Amendment (Emergency Measures) Bill 2020 means the NSW Housing Minister is now empowered to ban evictions.

These measures effectively transfer the risk from tenants to the landlords.

There are some measures to mitigate the financial loss that landlords are facing. For example, Queensland has introduced a COVID-19 Rental Grant entailing a one-off payment of up to four weeks rent (maximum of $2000) and in the ACT measures have been put in place to offer financial relief to landlords if they reduce rents for tenants doing it tough or are facing hardship themselves.

However, these measures provide only little help to landlords.

Obviously serviceability is a major factor for investors who rely on a stable rental income to cover the costs associated with property and particularly the mortgage. However, the current huge spike in unemployment among young people and contractors, who make up a large proportion of renters, is having a major impact.

In some areas, price reductions are highly likely which then make these properties harder to sell and this means some landlords will be trapped. All of these mean that landlords are facing major risks. This has a direct impact on potential investors. Investors are very responsive to out-of-pocket expenses, and to the risk these expenses will increase. Therefore, the vast majority of them will simply put things on hold and there has been  a sharp reduction in the demand for dwellings.

Major events impacting rental apartments

There has been a series of events that resulted in price reductions due to oversupply of units in many major cities, followed by the credit restrictions on local and foreign investors and then the potential changes to negative gearing and capital gains tax.

Last year the news of construction defects created major reputational damage to the whole industry, even in areas which weren’t affected, and now Covid-19 also has a potential impact on property prices and serviceability.

There has already been a sharp reduction in auction clearance rates over the past couple of weekends falling to a preliminary rate of 61.3% as of March 22 across the combined capital cities. Meanwhile, the Westpac-Melbourne Institute Index of House Price Expectations Index fell 6.6% in March, the largest monthly decline since February last year.

While some investors might feel it was a prime time to buy for long-term capital growth, prices will likely continue to fall as things are moving fast.

Cash flow risk materially increases

Cash flow is becoming a major risk particularly for rental apartments where renters are generally younger, often single millennials with no children, who also have more flexibility to either stay with parents longer or make changes to their place of residence.

For example, in the Inner West of Sydney, about 74% of units are rental properties and these are considered fashionable with the “young and trendy” who are now either unemployed or underemployed, making the risk of vacancy higher.

With all the current stock in the pipeline (in seasonally-adjusted terms, dwelling approvals for the December 2019 quarter increased in several states and territories, especially in Victoria with 26.7%t and South Australia with 6.9%), further increases in stock expected, a significant reduction in external migration and a large cohort of flexible renters who are likely to be materially impacted by the labour market. When you take all of this together, there is a higher material risk for rental apartments.

Reduced buyer demand for rental apartments

There has already been changes in consumer sentiment and auction clearance rates. So as these rental properties which are not suitable for families are largely bought by investors, many of them could be high risk regardless of cash flow from tenants as they could also be at risk due to serviceability issues.

It’s a two-fold problem of lower rental return (if they don’t have tenants) as well as their own ability to cover the shortfall between the rental income and the overall costs associated with the property. Even if there is a honeymoon from the bank, it still means while they are not paying the principal, interest will be accrued, and the cash flow will be way below their expectations.

The bottomline is investors need to be careful at this point in time. First, they should ensure that financially they are in a very strong position to service the mortgage or to potentially address longer periods of vacancy or provide a discount on the rent. Then, if they do want to invest, they should consider paying a discounted price for the unit to reflect both the risk for a price reduction and the cash flow risk associated with the property.

Lowest interest rates for 1-year fixed home loans

The comparison table below display some of the 1 year fixed rate investment home loan products on Canstar’s database with links to lenders’ websites available for a loan amount of $350,000 at 80% LVR in NSW, and available for Principal and Interest repayments. The results are sorted by ‘current rate’ (lowest to highest), then by provider name (alphabetically).

*Comparison rate based on loan amount of $150,000. Read the Comparison Rate Warning.

Lowest interest rates for 3-year fixed home loans

The comparison table below displays some of the 3 year fixed rate investment home loan products on Canstar’s database with links to lenders’ websites available for a loan amount of $350,000 at 80% LVR in NSW, and available for Principal and Interest repayments. The results are sorted by ‘current rate’ (lowest to highest), then by provider name (alphabetically).

*Comparison rate based on loan amount of $150,000. Read the Comparison Rate Warning.

Lowest interest rates for 5-year fixed home loans

The comparison tables below display some of the 5 year fixed rate investment home loan products on Canstar’s database with links to lenders’ websites available for a loan amount of $350,000 at 80% LVR in NSW, and available for Principal and Interest repayments. The results are sorted by ‘current rate’ (lowest to highest), then by provider name (alphabetically).

*Comparison rate based on loan amount of $150,000. Read the Comparison Rate Warning.


About RiskWise

RiskWise Property Research was formed in 2016 with the goal of providing property risk advice and research services to help its clients make informed purchasing decisions.

Its goal is to provide private investors, home buyers, property professionals and institutional clients with detailed risk information to support smarter decision making. Its vision is to be a global leader in property risk rating and research helping its clients to achieve deeper risk insights so they can make smarter property investment decisions.

Visit www.riskwiseproperty.com.au

As with all our content, Canstar’s Coronavirus coverage will always be free for our readers.

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