Sydney house prices are on the offensive.
NAB is predicting a 12pc rise in Sydney house prices over the next two years as property pundits eye up their next purchase. But how can you make sense of rising values as an SME? What does it mean for your business?
Sizzling demand and ever-tightening supply have created the perfect storm for the property market.
Despite a once-in-a-generation interest rate squeeze, prices are expected to surge by an average of 4.7pc across our capital cities this year.
Supply has not kept pace with demand. In fact, the number of new dwellings completed has been stagnant over the last 3 decades at around 25,000 annually, despite booming population growth. With migration caps lifting, these conditions are set to worsen.
But rising values can be a Midas touch for SMEs.
Rising values increase the equity stored in your assets, such as your premises or your land.
This gives you more leverage when looking for a loan.
When it comes to credit assessment, the value of your property security is the holy grail. Without fail, a more valuable property put up for security will allow you to access a higher value loan. It all comes down to the structure of modern debt arrangements.
With private lending the value of the property you can put up as collateral sets the ceiling on the amount you can borrow.
Let’s say you’re working with a lender that caps out at 70% LVR and your property is originally worth $1M. With those numbers you could get a maximum loan of $700,000. If your property was suddenly worth $1.5M, you’d be eligible for a $1,050,000 loan.
The difference is night and day. More equity opens up more opportunities for your business. You can fund your next move, whether that is expanding your premises, offering new services, or purchasing new equipment.
Rising property values can also attract new customers and businesses to an area, which can create opportunities for SMEs.
Rising property prices are a symptom of deeper structural changes in the economy.
Much of the increase in property values stems from population growth due to increased migration. Since international borders re-opened in early 2022, Australian cities have experienced surging growth which has buoyed consumer demand and kept the property market tight.
This shift is set to accelerate as the cap on permanent migration lifted for the first time in a decade.
As more skilled migrants enter Australia they stimulate economic activity, lift demand for property and increase interest in your SME’s goods and services. In either scenario, you raise your leverage and your ability to scale up your business.
The inflow of migrants will also remain strong over time against a relatively inflexible supply of housing.
Rising house prices are underpinned by strong confidence in the market, making it an attractive investment in the long term.
The Residential Property Index jumped to 33 points this quarter, well above the measly 9 points recorded during the first quarter. Property values have rebounded significantly faster than anyone expected. They have arrested their post-covid declines and forced the banks to reverse their forecasts.
SMEs with good property assets should be invigorated by these statistics. Investors are still eager to purchase property and will open their wallets for the right asset.
In turn, your ability to borrow will increase over time, as the equity stored in your portfolio compounds.
But there are some important downside risks to be aware of…
Affordability and accessibility suffer.
High property prices make renting, relocation, expansion very expensive. It dials up the financial pressure on your business and can become an unavoidable but painful line in your accounting records.
It is especially acute for SMEs renting commercial space. For SME’s reliant on physical space, their operating costs can balloon, straining their budgets and reducing their profitability.
If your business is located in an area with higher volatility, you may be over-exposed to declining values. This is especially true if you are on a loan with a higher LVR. Declining values against rising serviceability costs can make your debt unsustainable, prompting concern from your lender.
Let’s go through an example.
While your loan might have been rated at a 70% LVR initially, declining property values against a fixed loan amount mean that your LVR increases significantly. This can panic your lender. They may require you to pay down your loan back to the 70% LVR level or below, or increase their scrutiny of your repayment capability.
Uncertainty and instability.
The property market can be highly speculative, surging in a recession and collapsing in a boom.
This makes it an uncertain and risky asset. While Sydney prices are expected to increase, the gains could be reversed by further interest rate rises or sticky inflation. There are plenty of confidence killers waiting in the wings of the economy which could be dangerous.
If property values were to fall you might find yourself over leveraged. This increases your risk and liability in the event of a default.
Sydney’s surging property market has created strong opportunities for SMEs. But it is not without its risk.
For those with underlying property assets, they have seen their leverage grow dramatically, opening the door to exciting new opportunities. From funding business expansions to acquiring new assets – these SMEs are well placed in a challenging business environment.
Unfortunately, rising values has strong downside risks for SMEs without strong property security. That is why it is important to maintain a healthy balance of debt and equity, and talk with you lender about your changing financial situation.
Contact Sparrow Loans to address your financial needs today.