Commodity Boom: Fixed or floating interest

[GWD]

Hi Guys

We have just done our last ever live reno workshop last week-end ...and it was an absolute blast ...so being my last reno workshop I feel it is safe to put my toe in the somersoft door again after all these years.

What year was it when I had my 'hand smacked' for telling people I was doing reno workshops?

Maybe it was 2000?

'The Wife' was a force in the market at the time.

There is a paradigm change coming...I am asking for comment on the massive boom in commodities that is coming...it has the potential to change the face of our industry and has to affect our property market in a number of ways.


There is a wave on the horizon ...it's...its ...a super...commodity boom or energy wave.
there is a massive energy boom coming to Australia....the likes of which we have never seen before ...and according to Alan Kohler ABC news ....its bigger than the Gold rush in early Australia.

We all need to get ready for this so I am thinking of some of the effects in the near future.
Currently committed there is over $140 billion of projects.
Never before have we gone into a boom with unemployment of about 5%. Where are the workers going to come from ...the geologists, drillers, drivers, operators, miners, support people, clerks, computer people, medical staff and so on the list goes.
We basically have full employment so lets look at the options.

The Fed Govt (and the opposition) are still talking about small Australia...they have cut 457 temporary visa numbers... they have cut the student visa numbers in various categories... the Unions are resisting any increase in overseas workforce and saying it has to come from existing workers...if it does...and it can't totally ...(there is already talk about a 'energy visa') then there will be a wage push from the energy companies to get in first to secure the best and the brightest and ... eventually .... anyone with half a brain that can work...even from other trades

eg construction industry...or tourist industry...this has to push up wages and inflation ...and with an RBA target still set at 2-3% inflation ... so pressure on interest rates is inevitable.

We had a taste before the GFC where interest rates were nudging 9% ...but what is coming will dwarf that boom.
So everyone should now be considering their position on managing what will soon hit us.

My strategy to handle it is to pretend I am already paying 2% above current rates and that creates a 'buffer' if and when it (interest rate rise) happens.

I put my buffer into an offset account against my loans so it effectively lowers the interest by 2% and creates a buffer of cash should that be necessary.

It also will make you aware of what you have to do to handle such a rise should it happen...a bit like squirreling away nuts for a tough winter.

So if interest rates get to say 9% and you are absolutely stretched to the max ...the buffer will help get you through.

My opinion is at 9% the first home buyers who the Govt 'helped' to enter the market with the FHOG will start falling over as they entered the market at 5% interest and little deposit which means there outgoings have risen by 4% above their original 5% thats an 80% increase...very few could withstand that hit without further govt help or family welfare.

So those areas of FHOG'ers will have intense selling pressure and...they will be all selling at the same time in the same areas... and that is a recipe for a big dip in prices in those areas...some cashed-up investors see this as an opportunity & will be ready for this ...so let's see?

The FHOG'ers must be under big pressure even at todays rates.

Don't be suprised if it gets really nasty that the Feds bail them out with a low interest loan of some type or even pressure on the banks to quarantine interest rate rises for FHOGers.

I have seen it done before in a previous boom!

The discussion I would like to initiate is... what other risk management strategies could property owners/investors take ...maybe fixing part or all of their loans?

I have done this (fixing) in the past without great success but maybe this time is different...what do you think?

Geoff Doidge
Reno Kings
www.renos.com.au

 

[Ridin-High]

I don't think their will be blood in the streets.

I'll use an example from a couple at work.

One earns 80k, other earns 40k. Combine income 120k
They bought their first house for like 380k.
Say 5% deposit, no stamps. Loan 361k

Say 10% standard variable rate, with pro package discount 9.2%

$33212 + 5k outgoings

38k divided by 52 $735pw or 367pw each.
$367pw doesn't sound like Armageddon to me.


People keep saying BOOM BOOM, HIGH INTEREST RATES, FHB'ers are gonna die.
they don't really run any numbers.

Mind you as well most first home buyers have been paying principle payments as well, this has created a small cash buffer as well.

People can also get others to move in with them to rent.

After selling my share portfolio i can probably handle 12% standard variable rate now.

EDIT: also you say wage growth and inflation are gonna happen hardcore, which means ability to service debt increases because of wages and inflation reduces the value of the debt

 

[sash]

Geoff,

I view is that unemployment will push down further not only because of the boom conditions in commodities but also due to baby boomers calling it quits as the share market recovers. The impetus of the shortage will be primarily due to demographics more than commodities as it only employs 3-4% of our workforce.

The real shame is that this will put pressure on rates because the politicians are pandering to the "Bogan" vote and keeping the immigration restricted. The 5% who don't have jobs don't have the skills or the attitude to do these jobs. Lets face it....Australia has to realise that without immigration it would be the country it is now economically.

On the rates front....the FHB buyer are already falling over. More will fall over well before 9%!

I for one started fixing. I have managed to quarantine most of my portfolio with locking in rates at under 7%. The rates will remain high till about the end of next year before they come down...I can see them below 7% till are well into 2012....where a new property cycle will begin in most states.

Fixing rates has been a core part of my strategy over the last 10 years....it helps you manage risk. I am sure you will see some SSers...particularly the less experienced get hit hard with rates.

Hi Guys

We all need to get ready for this so I am thinking of some of the effects in the near future.
Currently committed there is over $140 billion of projects.
Never before have we gone into a boom with unemployment of about 5%. Where are the workers going to come from ...the geologists, drillers, drivers, operators, miners, support people, clerks, computer people, medical staff and so on the list goes.
We basically have full employment so lets look at the options.

The Fed Govt (and the opposition) are still talking about small Australia...they have cut 457 temporary visa numbers... they have cut the student visa numbers in various categories... the Unions are resisting any increase in overseas workforce and saying it has to come from existing workers...if it does...and it can't totally ...(there is already talk about a 'energy visa') then there will be a wage push from the energy companies to get in first to secure the best and the brightest and ... eventually .... anyone with half a brain that can work...even from other trades

eg construction industry...or tourist industry...this has to push up wages and inflation ...and with an RBA target still set at 2-3% inflation ... so pressure on interest rates is inevitable.

We had a taste before the GFC where interest rates were nudging 9% ...but what is coming will dwarf that boom.
So everyone should now be considering their position on managing what will soon hit us.

My strategy to handle it is to pretend I am already paying 2% above current rates and that creates a 'buffer' if and when it (interest rate rise) happens.

I put my buffer into an offset account against my loans so it effectively lowers the interest by 2% and creates a buffer of cash should that be necessary.

It also will make you aware of what you have to do to handle such a rise should it happen...a bit like squirreling away nuts for a tough winter.

So if interest rates get to say 9% and you are absolutely stretched to the max ...the buffer will help get you through.

My opinion is at 9% the first home buyers who the Govt 'helped' to enter the market with the FHOG will start falling over as they entered the market at 5% interest and little deposit which means there outgoings have risen by 4% above their original 5% thats an 80% increase...very few could withstand that hit without further govt help or family welfare.

So those areas of FHOG'ers will have intense selling pressure and...they will be all selling at the same time in the same areas... and that is a recipe for a big dip in prices in those areas...some cashed-up investors see this as an opportunity & will be ready for this ...so let's see?

The FHOG'ers must be under big pressure even at todays rates.

Don't be suprised if it gets really nasty that the Feds bail them out with a low interest loan of some type or even pressure on the banks to quarantine interest rate rises for FHOGers.

I have seen it done before in a previous boom!

The discussion I would like to initiate is... what other risk management strategies could property owners/investors take ...maybe fixing part or all of their loans?

I have done this (fixing) in the past without great success but maybe this time is different...what do you think?

Geoff Doidge
Reno Kings
www.renos.com.au

Ridin-High

I agree with you that most people will not be affected....but it could be higher then the less than 1% repossession rate this time around. Why...because most people are struggling to pay their bills on the wage below.

The scenario you have given below is pretty conservative. With the income below most people would get into a 550k house because they would turn their noses at a 380k house. Just human nature!

On that basis assuming the income levels below...their net wage would be about 95k....their mortgage on say 525k on 9% would be closer to 50k. That leaves 45k to live on....add a couple of car loans and they have very little to move. If one gets sick or loses their job for extended period they are in trouble.

I don't think their will be blood in the streets.

I'll use an example from a couple at work.

One earns 80k, other earns 40k. Combine income 120k
They bought their first house for like 380k.
Say 5% deposit, no stamps. Loan 361k

Say 10% standard variable rate, with pro package discount 9.2%

$33212 + 5k outgoings

38k divided by 52 $735pw or 367pw each.
$367pw doesn't sound like Armageddon to me.


People keep saying BOOM BOOM, HIGH INTEREST RATES, FHB'ers are gonna die.
they don't really run any numbers.

Mind you as well most first home buyers have been paying principle payments as well, this has created a small cash buffer as well.

People can also get others to move in with them to rent.

After selling my share portfolio i can probably handle 12% standard variable rate now.

EDIT: also you say wage growth and inflation are gonna happen hardcore, which means ability to service debt increases because of wages and inflation reduces the value of the debt

 

[Rolf Latham]

Hi Geoff

Welcome back.

There is no general answer to this puppy.

It very much depends on any personal financial circumstance and risk tolerance.

I think your question relates more to macro economic issues than a specific "what should I do" for a reader.

The current and future economic future is hard to read.............even the RBA seems to be a little out of congruence with the data it uses and what it "openly" says it wants to achieve.

I believe Australia's biggest issue is the amount of foreign debt we have, as individuals, as gov, and as corporations.

As at today, I have still not hear or seen any logical and believable explanation why Australia would have the highest effective interest rates in the western world, AND has had these since the dollar floated.

So, getting back to your question..............

I believe that for most high volume investors, that have high lending exposure relative to their income, they should consider a strategic middle to long term fix.

This doesnt mean going out and taking all your 2 mills worth of debt and putting it on black

This means fixing some and leaving some on float in such a way so that you still have some lending flex, and spreading the maturity.

Many of our clients with rate risk concerns have locked away over the last 18 mths............Some for as long as 10 years and rates as "low" as early 6s for 10.


ta
rolf

 

[jonmardell]

it is almost impossible to predict rates as we have seen recently. If you are very concerned that interest rate rises are going to affect you then fix rate is for you, if you are only mildly concerned about rate rises then think about fixing part of your mortgage and if you are not concerned at all and you have a large surplus cashflow at the end of the month then ride the wave Fixed versus variable is really up to peoples personal situation cause a couple of years ago when rates were rising, a lot of people fixed right at the peak and it hurt them as it came tumbling down.

 

[Corey Batt]

Thank gods lots of those silly FHB's had car loans, personal loans etc. which limited their borrowing ammounts even though they could afford technically lend higher amounts.

The suggestion that FHB's are lend to the teeth sheep is a bit silly, I cannot for the life of me think of one FHB who has lent to the max in the last 3 years.

 

[Ausprop]

It would be unfortunate that in attempting to cool a boom that hasn't happened yet the RBA actually tips us into a technical recession

 

[Ms Jade]

It would be unfortunate that in attempting to cool a boom that hasn't happened yet the RBA actually tips us into a technical recession

Exactly what I was thinking with the last rise.
However, if their predictions are true about the size of the coming boom my safety mechanism says to fix most of the debt. Fixed rates look v. reasonable to me and SVRs nudged 9.5% around August 2008. I've said it before, but we have short memories with these things. If we usually fix rates to achieve certainty about the future, and if the times are particularly uncertain (IMO there's a case for this), then now may be the time to consider fixing.

 

[Tom-B]

I've just gone through the process of fixing both IPs and most of the PPOR - the little bit that is variable is almost fully offset with cash anyway.

These are my reasons;

-Fixed is pretty damn close to variable right now
-Fixed rates are also near enough to the long term average SVR
-Knowing my nearly $1M of debt is serviceable now, and will be for the next 3 years helps me sleep at night.

-I'm also bearish (or is it bullish) on interest rates.
-There is simply too much money in the pipeline about to be tipped into the AUS economy - inflation has to be a by-product

The only thing will be to watch what Jool's does should high rates start tipping FHO's out of their McMansions - remember she is communist at heart, they could look at radical ways to keep rates artificially low for FHOs and put a floor under prices / repos should they start to take off.