The economics of competition in business is a well-documented area and has sparked plenty of interest over the years.
Have you ever played the game 'Monopoly'?
If so, you would have had a brief insight into the world of competition in business. For example, if one person owns all the properties, they rule the game and have a monopoly over their other players, but if ownership is spread across the players, the game is much more competitive.
This concept is scattered throughout the economy and is the foundation of price control amongst many businesses.
Think of petrol providers. When you drive your car around the city and see all the fuel stations, you'll notice their prices are all quite similar. Of course, there will be some that are marginally cheaper and some that are marginally more expensive, but you'll never find any that are significantly cheaper.
There's a reason for this.
Because petrol companies care about their profits, and if they undercut all the other companies on price, they might attract a more significant portion of the business. Still, profit margins will be slimmer, and the risk of financial collapse is higher due to more reliance on volume. Alternatively, if they price themselves more elevated than the competition, their profits will be higher, but they will lose a portion of the market and therefore lose business overall.
So that's economic competition, but how does this relate to the property market and investors?
It all starts with the banks.
Banks (and other lenders) generate profits by earning more from their loans than it pays for their funds. This margin is what the Reserve Bank of New Zealand (RBNZ) calls the "net interest margin".
Therefore, it is in the bank's best interest to charge high-interest rates to generate a high profit. But, they can only set their rates to a certain level because other banks also compete in the same space, so the competition keeps prices at competitive levels.
The official cash rate (OCR) sets the rate banks to borrow short-term money from the RBNZ. When the RBNZ wants to stimulate the economy, the OCR is set low to encourage spending and borrowing and discourage saving. Conversely, when the RBNZ wants to restrict the economy, the OCR is raised to encourage saving and discourage borrowing.
Generally speaking, when OCR goes up, so do home loan rates.
As a bank, being too slow to lift their rates or too slow to drop them can affect profits as the other banks take the marginal gains during these periods of strategic change.
Property investors are exposed to interest rate changes but can use competitive rates when the banks want to get more business.
At the time of writing this, some banks are offering discount floating rates, discount fixed 1yr rates and more that are well below what is considered "market price" and the reason for this is to attract more business simply.
When really attractive deals are on offer from the banks, more people are inclined to go through them to get their lending, and the overall market share of that business increases.
In the same way, competition affects interest rates; developers and vendors are also affected by competition by being forced to price according to the market.
In a soft market, vendors are forced to lower their prices to attract new business at the expense of having lower profit margins. However, there is one big difference. Vendors and developers are on a much smaller scale than large banks, so their ability to drop prices is much higher, leading to more competitive deals being offered behind the scenes.
Working with real estate agents, financial advisors, and buyers agents who have the know-how to help facilitate these discounted transactions is an excellent way to ensure you're capitalising on your investment options.
As an investor, periods of economic downturns opportunities for undervalued investments with the caveat of higher interest rates.
But, if you can source a 'cheap' property and access some of the competitive deals the banks offer, then your investment returns will be far superior.
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