Interest Rates & the Australian property market

Antony Cohen Co-Founder & Head of Funds Management – LongView

 

What is going on with interest rates and what does it mean for the property market? 

The interest rate story so far this year: 

 

• The Reserve Bank of Australia (RBA) has increased the official cash rate six times since April this year by a total of 2.5%, from 0.1% to 2.6%.

 

• The RBA has done this to try to reduce inflation back to the target range of 2-3% per annum from a rate expected to be around 7.75% by the end of 2022.

 

• The increase in official interest rates has flowed directly through to mortgage interest rates leading to a significant increase in the cost of servicing a mortgage for those who are not on a fixed interest rate mortgage.

Facts to know

 

• When Banks are considering loan applications, they are required by the APRA to allow for a 3% increase in interest rates in assessing whether a borrower is likely to be able to service the mortgage. 

 

•  So, at this stage, with rates having risen 2.5%, the vast majority of borrowers should be able to meet the mortgage payments – albeit that they may have to reduce some other discretionary spending they may have become used to making. Therefore, we should not expect to see a large number of borrowers who must sell a property because they can no longer afford to hold it. 

 

Will interest rates continue to rise and if so, how much more? 

 

• The RBA may continue to raise interest rates if it sees a need to do so in order to get inflation back to the target range. There are (or at least were before the recent flooding in Australia) some early signs that inflationary pressures may be easing – for example, some of the issues in fuel and food prices caused particularly by the Russia – Ukraine war have begun to ease. 

 

• In Australia, a significant factor has been the increase in the cost of construction of homes which has risen by 20% in the last twelve months, with this alone adding 2% to our inflation rate – the rate of increase in this factor is easing partly due to reduced construction activity as a response to these higher costs.  

 

• Recently the Big 4 Banks’ predictions for interest rates have suggested further increases ranging between 0.25% and 1.0% (making the forecast peak official interest rate in the range of 2.85% to 3.6%). So, while further rate increases seem likely, we may well be towards the end of the current cycle of increases, with the extent of further rises likely much smaller than the 2.5% already in the system. 

What does this mean for the property market? 

 

 

If we were to believe all the daily media headlines, we would expect these interest rate increases to flow into very large (up to 20% or more) reductions in house prices.  

We think this is unlikely.  

 

• We think this analysis misses the fact that the gearing in most residential properties is quite low – on average, the loan-to-value ratio is around 21%. It is the small portion of very highly geared recent or intending home buyers whose capacity is affected to such an extent as to cause a decline of this order of magnitude for the properties this group of buyers typically compete for. 

 

• We also think this analysis ignores the capacity of most owners to decide whether or not to sell a property now or to wait until market conditions are better. This can already be seen in the relatively lower volumes of stock for sale on the market at present than is often the case. 

 

• As further support for this view in analysis, we will be publishing quite soon on the factors which drive residential house prices in Australia. We find little evidence that interest rates drive house prices over the long term. 

 

Want to know more about this subject contact us today to talk directly to one of our expert buying advisors.