Investor loans at risk of default

Rental yields on houses in Australia's two biggest cities, Sydney and Melbourne, have declined to record low levels, Moody’s said in a research report published this week.

“As a result, the net costs involved in servicing a housing investment (investment loans costs less rental income) have increased relative to household incomes, making investment properties less affordable,” the report said.

The report highlighted that low rental yields combined with deteriorating affordability “increase the risks and default probability for Australian residential property investors and therefore for Australian RMBS backed by loans on residential investment properties.”

Affordability of servicing properties is now at its worst levels on record, according to the report.

“The affordability of residential investment property – defined as the net cost of servicing a residential property investment as a percentage of net household income – is at the worst level on record for investments in houses in Sydney and houses and apartments in Melbourne, and the worst in 10 years for investments in Sydney apartments,” it said.

Moody’s calculated that investors in Sydney houses require 39.6 per cent of net household income to service their investment properties, while Melbourne house investors require 26.5 per cent, both record highs.

“The deterioration in the affordability of servicing investment properties makes residential property investors more vulnerable to risks such as loss of income, interest rate increases, vacancies or rent reductions,” the report said.

“Should an investor suffer a loss of income, the higher cost of servicing their investment property will diminish any saving they may have at a faster rate, leaving the investor with less time and flexibility to recover and therefore increasing the probability of them defaulting on their loan.”

The warning comes as the market prepares for further out-of-cycle rate hikes, which will put even more pressure on those servicing a mortgage. Bank of Queensland will raise their variable rates on Friday, with many predicting more banks will follow. 

“Any increase in interest rates, vacancy or loss of rental income will make investment properties even less affordable and increase the probability of investors defaulting on their mortgage loans,” Moody’s said.

The report said if mortgage interest rates were to increase from the current average of 5.95 per cent to 7 per cent (the average for the past 10 years), the net servicing cost for an average residential property investment in Sydney and Melbourne would increase by approximately $5,000 a year or about 5 per cent of net household income.

“The same increase in interest rates three years ago would only have resulted in an increase of $3,500 in net servicing cost,” the report said.

“The decline in the affordability of servicing investment properties also reduces investors' flexibility around refinancing or restructuring their mortgage loan terms, giving them less options should they experience hardship and therefore increasing their likelihood of default.”

[Related: Default crises looms for off-the-plan buyers]