The Danish Experiment
Danish banks have launched the world's first negative interest rate mortgage. Borrowers are effectively paid interest to take out loans.
What does this actually mean for borrowers?
Negative interest rates effectively mean the banks pay a borrower to take out a loan. Ultimately, they are paying back less than what they have borrowed.
As an example, if you as a borrower want to buy a house and need to obtain a loan for $1 million, current 10-year fixed rates are on offer at -0.50% - the bank will reduce your loan every month (instead of being charged interest); and 20-year fixed deals at 0.00% - no cost.
How is this possible?
It is possible because the banks themselves are able to borrow from money markets at negative interest rates. They are simply passing some of this on to customers.
While the Reserve Bank of Australia currently has a base rate of 1.00%, the European Central Bank's main base rate is 0.00% and in Denmark (which isn't in the Eurozone) the equivalent rate is -0.40%.
For the most part, banks in Denmark are borrowing money from investors at rates even lower than this.
Why would investors expect a negative return?
Savers and investors are being penalised for keeping their money in the bank. This is happening across several developed countries such as Switzerland and Japan where banks are charging savers for keeping their money in the bank.
Ultimately, the system being implemented in these countries is being designed to stop people from hoarding their wealth in cash and force them to invest it to help stimulate their economies.
Where are interest rates heading in Australia?
For the most part, the Reserve Bank of Australia has ruled out negative interest rates. Last week, the Deputy Governor of the RBA answered a question on how low interest rates could go and responded with the following:
If you look what happened in the US, Canada, and the UK, when they got down to their lows it was somewhere around zero, quarter, half a percent. And so I think that probably gives us some sort of guide as to what the equivalent might be here.
This is broadly consistent with what the RBA Governor has previously said, although in June 2019 when questioned about the prospect of negative interest rates, the Governor responded with "I am very hopeful that we will not need to go, certainly into negative territory, or to these very low interest rates."
The fact that the Deputy Governor did not mention examples of negative rates last week suggests the global experiences that the RBA is drawing most of its lessons from are the US, UK and Canada.
What happens when interest rates go so low?
Savers are penalised. Asset values go up. Yields begin to compress. Competition to place capital increases. Money earning negligible interest in the bank is best deployed into investments.
It is typical that investors need to go higher on the risk spectrum to obtain higher returns i.e. speculative investments / development opportunities.
We are seeing assets trading at yields from 50 to 75 basis points lower than they were a year ago, reflecting this increase in competition. As an example, we purchased our Helensvale Childcare Centre in February 2019 at a yield of 6.68% with comparable centres now trading at yields sub-6%.
Whilst it has taken us some time to adjust our own thinking on yields for new acquisitions, we are now firmly of the belief that investors should expect lower interest rates for longer and correspondingly lower returns.
Helensvale Childcare Centre - Tax Time
Muse Capital is pleased to report that we have completed our first Tax Return for the Helensvale Childcare Centre Trust.
Due to the significant depreciation benefits of the brand new centre, all dividends paid to investors (currently 7.20% pa) were fully taxed deferred i.e. no tax being payable on dividends to investors.
Mel Pikos
Managing Director
Muse Capital