Where is the apartment market’s tipping point? When does it make more sense to buy rather than rent?
And while we are at it… where is the tipping point for investors to buy apartments?
As it turns out they are both about the same.
Obviously, there are lots of non-financial drivers to buying property, but if we just focus on the money, the decision to buy vs rent, or for investors to buy, is driven by 3 numbers or markets.
- Rental rates
- Interest rates
- Capital values
For tenants, when their rent exceeds the loan repayments (plus ownership costs) they are better off owning vs renting. That is simple logic assuming they have saved up a deposit.
For investors, when the rental income exceeds the loan payments (plus ownership costs) by a sufficient amount, investors will start to buy.
As you can see high rents and low interest rates are encouraging markets for both tenants and investors to buy property. When each of the 3 markets are in the right proportion we reach the tipping point. Loan repayments are a ratio of interest rates (2) and capital values (3). If rental rates become greater than the ratio of 2 and 3 for the specific purchase and deposit the market tips.
As we saw in the story on apartment investment returns, rental rates have risen faster than capital values and are now showing annual returns of between 6% and 9.5%. With interest rates expected to fall throughout this year, and rents to rise, the ratio between them will continue to get more attractive for buyers.
Let’s say a 2-bedroom apartment rents at $750/wk which is $3,260/ month.
Assuming it is worth $650,000, the interest payments at 5.5% are $2,980/month.
Add in ownership costs of say $550/ month and we are getting very close to the tipping point.
Rent at $3,260/mth vs own at $3,530/mth.
A slight shift in rent, interest rates or value can tip the numbers over to buy for both tenants and investors.
This is why a drop in interest rates will make an impact in the property market. While a reduction of 0.25% or 0.5% doesn’t move the needle significantly in terms of loan repayment amounts, it can tip the decision scales from renting to buying. These market conditions are also attractive for investors, so the effect is amplified.
For investors the numbers are currently working better for one-bedroom apartments. This is mainly because most owner occupier buyers are looking for 2-bedroom apartments so there is less competition for 1-bedroom apartments.
Each market has its tipping point. Once the numbers line up so do the buyers.
