REVISITING RATES: IMPACT ON PROPERTY PRICES? ☝️ OR 👇
Interest rates in our marketplace, which is a 'free market', are set when lenders (public and/or private) compete for the business of home buyers, the levels of competition and other economic factors cause movement in the interest rate levels associated with mortgages either up or down. Now the Reserve bank has slashed the interest rate to a historic low of 0.1% in a bid to prop up the Australian economy, homeowners can now secure fixed-rate mortgages for 1.89-1.99% (this may vary), not in my lifetime did I expect to see rates this low, and I use to trade interest rates professionally on the stock market in London.
The next move for these rates (assuming they no longer go negative, which I am sure they will not) will be to gradually start climbing again. So, what if rates double to say 4%+, what impact does this have on house prices?
It is easy to assume that in real estate, rising interest rates make things more difficult by increasing the associated costs of owning property and that the reverse is true as well.
Impact on Buyers
Using a simplified example, if a home buyer wants a 2% rate on a mortgage worth $1,000,000, the weekly payments would be approx. $924 (30-year term/ Principal+Interest/Live-In).
If rates go to 4%, on the same mortgage worth $1,000,000, the weekly payments would be approx. $1,194. an increase of $270 per week, or a 29% increase.
Therefore, the bank is likely to adjust its lending amounts in correlation to the purchaser's ability to service the loan repayments. The impact this has is that if rates continue to rise, say they move up again to 5%, then the bank will only lend the amount of money based on the mortgage applicant’s ability to keep up with the repayments unless the income of the applicant moves up in line or greater than the rate increase then their borrowing power will be less.
Impact on Sellers
Raising interest rates can affect sellers differently. Using a crude example, if Emilia wants to sell her house for $1,000,000 and markets it for sale with such price expectations, she may find that the level of competition for her home is reduced (competition drives prices), because buyers can now afford to borrow only $900,000 based on their income and the lending criteria set by banks. So Emilia's pool of buyers has reduced as a result of the increased rates.
Emilia can still make a profit of course if she times and plays the market well enough. But what this should indicate is that a rapidly increasing rate environment can have a direct impact on the slowing and/or decreasing of housing prices.
Impact on Property Prices
There is no doubt that rising rates can have a clear effect on both buyers and sellers. There are situations that can help explain that housing prices have a direct correlation to the mortgage rate, but what is of critical importance to this is the health and prosperity of the underlying economy.
If the economy is growing at a fast enough and sustainable rate, then the impact on housing prices shouldn't be too dramatic. This is a result of the overall outlook, for example, if mortgage rates were hiked 1% on a $1,000,000 loan, then the weekly increase would be $130. If the economy is buoyant then employers should be able to increase the salaries of individuals in line or above this increase in their home costs. If the economy continues to strengthen in line with and/or better than rising rates, with continued job growth and wage growth, then the impact of the rising rates will not have a paralysing effect on housing prices, they can work together.
Impact on Real Estate Investing
Effects on buyers and sellers are very noticeable, but what about investors who already own property, well a rise in rates can be of great benefit!
Competition and scarcity drive economic markets. If rising rates lead to a reduction in real estate transactions, because of tougher lending standards, for example, more people will need to rent whilst they work on saving towards a sustainable mortgage. If fewer people are qualifying for mortgages owing to higher rates and seller expectations still high, then there will be increased demand for rental properties, which could push rental prices and therefore yields higher.
Adversely, if the rising of rates does put some downward pressure on prices, then former tenants may decide that it is better to buy into the market at a time when demand for buying properties is reduced.
Buy or Sell?
Not buying into this market purely based on the fear of rising rates should be dismissed. Please note however there is a myriad of considerations before taking the plunge. What is undeniable though is that debt has never been cheaper either in our lifetimes or that of our ancestors. "Interest Rate in Australia averaged 4.07 percent from 1990 until 2021, reaching an all-time high of 17.50 percent in January of 1990 and a record low of 0.10 percent in November of 2020." (Source)
Selling can also be a wise move if it fits in with your overall strategy, the demand for property is statistically just coming off of a 30-year high.
Summary
When the economy is strong, interest rates tend to rise along with growth.
Higher interest rates, however, translate into higher mortgage loan costs.
Rising rates may affect home buyers and sellers alike.
Thought to conclude...
Economic theory can be referred to as a zero-sum game, this means that if the total gains are added up and total losses subtracted the result is zero. Why is this relevant? If you are the purchaser of a $1,000,000 property today and I am the seller, then the property (out with associated costs) exchanges for that amount. As the seller, I may have gained $500,000 in profit having bought the property 15 years ago and now settling into retirement, whereas the buyer will look to realize that profit over the next 15 years whilst primarily enjoying the home first or adding to a growing property portfolio.
If you need any real estate advice or just want a price check on your home, please get in touch and we will respond immediately.
Written and published by Edward Smyth, Former Chartered member of the Securities and Investment Institute (UK) and founder of Smyth Real Estate
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