The current low interest rate environment is wonderful for borrowers but disastrous for yield investors.
The way the media reports it the current historically low RBA cash rate of 1% provides ample incentive for borrowers to load up on more and more debt at lower and lower costs.
But what of the hard done by yield investor? They are struggling to cope in a low rate world that looks like it will get a lot lower before it improves
Yield investors may exist at any age but are more likely to be older and seeking out yield for a regular income and security of capital. These investors may have funds in Super in Pension mode and hold a certain percentage in yield based investments to provide income and capital protection.
Unfortunately the income side of this equation has dropped a lot on the past 2 years and will likely continue down in coming quarters.
The RBA stated this week that the official cash rate may well be cut to ZERO to help assist the economy to resume its growth.
This is all fine and well but what will this do to interest rates on yield investments?
According to the authoritative Canstar website savings accounts are at an anaemic 0.5% to 2.15% depending on “bonus interest “ being paid if you meet certain transaction benchmarks (regular deposits and no withdrawals etc)
Term deposits are a little better with some banks (at best) offering just over 2% for 6 months and 12 month terms. The downside is a lot of the offerings are from institutions you may not have even heard of. And while the Federal Government guarantees the first $250,000 at each “authorised deposit taking institutions” the comfort level for a lot of people may not be there to deal with these groups – well at least not yet.
Government bonds or Fixed Interest investments are likewise returning low levels that reflect the low official cash rate. The Ten year Bond rate is currently yielding a paltry 0.992%. Other corporate bond rates offer a higher yield but are riskier.
Official Inflation in Australia is currently running at 1.6% so the rates being offered means many investors are getting a “negative” real return on their funds
The issue at its most basic level is this:
Is the return you are receiving on your capital adequate to provide an after inflation (or real ) return to you.
Whilst official inflation is 1.6% what about “real inflation”?
What is your “personal inflation” on the goods and services you spend your hard earned on. We don’t all buy a new flat screen TV every six months but these have come down dramatically in the five years impacting on the official inflation rate. Likewise many common but volatile goods are stripped out of the official rate
So consider your own personal basket of goods and services when working out your personal inflation rate. What do you see rising in the goods and services you buy regularly;
What are your Fresh fruit and vegetables costing you lately?
How has your electricity bill altered in the past five years?
Health insurance premium rises?
School fees (if you are still paying them or helping out with your grandkids costs)?
The price rises over your personal essential items (that impact on your financial well being) will dictate how much return you need from your investments to keep ahead of inflation.
So if cash and fixed interest are poor what options do investors have?
Besides rushing head long into shares with all of their inherent volatility and increasing the overall weight of a portfolio to this sector members need to think outside the box.
What about Commercial Property? Same as shares as a lot of investors have exposure already and volatility is inherent in this growth asset.
Secured Mortgages are the potential missing piece.
Secured mortgages are simply – as the name suggests- mortgages secured over property assets. Investors are effectively becoming a bank by lending directly (or indirectly through an institution) to property developers.
There are a number of financial institutions that operate in this niche market. These are facilitators of secured mortgages that are fixed interest investments that are back by first mortgages over (usually) commercial property.
Secured Mortgage investments are not property investments, as such but are backed by property. You are not becoming a part owner of a commercial property but are simply a lender to a developer of that property and your loan is secured by a first mortgage over the property in question.
They tend to be offered by a number of large providers in a pooled offering (exposure to a number of mortgages) or directly over a particular development.
How risky are they ?
They can be very risky and are not an instrument to go into unless you are well versed in what you are actually investing in.
They are not comparable to or a replacement for government bonds or highly rated corporate bonds but you are compensated for the higher risk with a higher return.
Some of the offerings currently are in the 5 to 10 percent range which is a lot higher than traditional bonds BUT they are a lot higher in RISK
The first mortgage over commercial property usually occurs at a Loan to Value Ratio (the size of the loan compared to the value of the assets being secured) of approximately 65% gives some comfort.
However in the event of a borrower default or a major collapse in the value of the commercial property sector the actual facility may well be “frozen” until the asset can be seized and sold. In this case you lose access to your funds and to the income you were receiving.
This is the reality of this type of investment.
They offer attractive headline returns but with this return you assume the risk.
Whether these are suitable for your situation is determined on an individual basis.
If you have considered this type of investment or would like to discuss this further with your adviser please call 1800 804 296 to book an appointment.