Interest Rate effects on Prices

WHAT DO RISING MORTGAGE RATES MEAN FOR

HOUSE PRICES IN AUSTRALIA?

Some investors think interest rate rises means less people can afford property, and therefore as demand drops, prices won't rise. Or worse, as some people think, they may actually fall.

In fact the Citylife Groups study of house prices and interest rises has revealed in fact the opposite may in fact occur. That is, house prices may boom after interest rates go up.

At first glance, this claim seems impossible to believe.

How can rising interest rates, which make property LESS affordable for both investors and for home owners, cause prices to rise, and even boom?

Well firstly, it is because the market is not only governed by interest rates. There are many factors that come into play. And economic conditions, rental demand and population and migration increases all play a part.

But one of the big factors is supply and demand, and the amount of new homes being built.

So lets first have a look at the current supply (or lack of) new houses in , and focus on Sydney.

SHORTAGE OF HOMES:

The Graph below shows the current estimated levels of shortages of new homes.

The last time Sydney had such an acute shortage was in the mid 1970's. Prices rose then in the years following 1975 by a total of 87%, (as shown below) at a time when Mortgage interest rates were between 9.88% and 10.38%, significantly higher than today’s rates.

Interest rates were 8.38% in 1974, and then rose to 10.38% by January 1976. House prices then rose as follows:

1976 up 10.5%,

1977 up 5.7%

1978 up 16.3%

1979 up 35%

1980 up 35%.

INTEREST RATES:

Now let’s look at interest rate trends in over the past 38 years.

As can be clearly seen from the Citylife Property Group graph below, the interest rates have tended to start major rises every 6 years or so, in 1974, 1980, 1986, 1994, 2000 and 2006.

So let us look and see what growth actually happened in property prices for the 5 years immediately following each interest rate increase: (source: Citylife Property Group Research based on the Medium Sydney house price as reported by the Real Estate Institute of Australia)

1974 rise in interest rates from 8.38 % to 10.38% (January 1976)

Prices rose by 66% (to 1979).

1980 rise in interest rates from 9.13 % to 13.5% (Feb 1982)

Prices rose by over 32% (to 1985).

1986 rise in interest rates from 13.5 % to 17.0% (June 1989)

Prices rose by over 75% (to 1991).

1994 rise in interest rates from 8.75 % to 10.50% (May 1996)

Price rose by over 52% (to 1999).

2000 rise in interest rates from 6.8 % to 8.05% (January 2001)

Price rose by over 63% ( to 2005).

2006 rise in interest rates from 8.2 % to ? %

Property prices up by ? % .

So it’s very clear that interest rates have absolutely no negative impact on house price inflation, and in fact seem to may have a positive effect.

How do we then relate this fact with the feeling most people have that that interest rates and the housing market are closely related?

WHY ARENT PRICES DROPPING?

Why aren’t prices dropping, and why does it seem they have NEVER dropped after interest rate increase start?

Because supply drops too.

For home-owners they will generally not sell if they think prices have dropped.

For investors, when interest rates rise, the viability of getting an investment apartment or two is reduced.

Therefore the lower number of property purchasers means less rental stock available, and rents increase. (Exactly as can be seen in 2007-2008)

This rent increase to investors will reduce the impact of the higher interest rates, and their position after a couple of years remains the same cash flow wise. (unless interest rates reach astronomical levels)

There is also a perverse positive impact on negative gearing , where the higher interest rates means some investor are able to benefit from increased tax breaks.

As rents continue to rise, and yields improve, more investors come back into the market, forcing price rises through. As interest rates eventually come off, the investors tend to flood back into the market like lemmings, snapping up all available properties, creating even more shortages, causing more price rises!

So there you have it.

CONCLUSION

Overall, one can reasonably say that Sydney property values are as safe now as they've ever been. And in fact with the shortage of supply, rising rents, and high occupancy rates, it is be a better time than for many years to enter the market.

As long as someone is not over borrowed, there is no reason the current rising interest rate climate needs to be given more than a cursory glance.