Rock Bottom Rates = Sky High Property Prices
If the property market extrapolates rates being lower for longer, as the bond market has done, this warrants much higher property prices.
David Moore
Property prices are very sensitive to interest rates. As rates fall, mortgage payments fall, affordability improves, and borrowing capacity increases. Buyers can bid higher amounts, driving prices higher. This is what’s unfolding now.
Due to record low interest rates, household interest payments now represent just 5.7% of income, the lowest in 36 years. It’s no wonder prices are marching higher.
Rock bottom rates, but for how long?
With the official cash rate at 0.10% and mortgage rates under 2.00%, interest rates are already at rock bottom. But how long will they remain around these historic lows?
Whilst nobody knows, the best clue is the $1.2 trillion government bond market, which is dominated by professional investors. Australian 10year bonds return 1.2%, 20year bonds return 1.9%, and 30year bonds return 2.1%. If we assume these investors expect to earn a positive return after inflation, it means they expect inflation to be something less than 2.0%. This is not a forecast; this is over $1 trillion in professional money betting that inflation will remain below the Reserve Bank’s 2.0% - 3.0% inflation target for at least the next 3 decades! This is important, because as night follows day, low inflation means low interest rates.
Reserve Bank stance
Recently the Reserve Bank commented “The Board is committed to maintaining highly supportive monetary conditions to support a return to full employment in Australia and inflation consistent with the target. It will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, the labour market will need to be tight enough to generate wages growth that is materially higher than it is currently. This is unlikely to be until 2024 at the earliest.” With the cash rate likely to remain at 0.10% for at least another 3 years, mortgage rates are likely to remain below 2.00% for at least another 3 years. Indeed, they could hover around these levels for decades, as they have in Japan.
Really?
There’s an element of disbelief that rates are this low, and a pervading sentiment that because they are at rock bottom, they are about to go up. However international experience in North America, Europe and Asia tells us that rates can approximate zero for a very long time. Technological change, demographic shifts, globalisation and elevated debt levels are structural forces that continue to suppress wage and price pressures, and in turn, interest rates.
Sensitivity of property prices to interest rates
Knowing how sensitive property prices are to interest rate changes, it’s also worth knowing that prices increase exponentially the lower interest rates go. When rates fall from 10% to 9%, that’s a 10% reduction in the rate. When rates fall from 2% to 1%, that’s a 50% reduction in the rate, prompting a proportionately higher change in price. This mathematical construct is known as convexity in the bond market, where rate movements are automatically reflected in prices. The property market is far less efficient, operating with significant lags, however the principle remains. If the property market extrapolates rates being lower for longer, as the bond market has done, this warrants much higher property prices. This is what we expect in the years ahead.
Compelling opportunity
We consider South-East Queensland the lowest risk property market in Australia, and the one likely to deliver the highest capital gains in coming years. A confluence of factors have created a compelling opportunity for home buyers and investors. We leverage the opportunity by buying quality properties in great locations, ones offering scarcity value and an infrastructure catalyst.
To discuss how we might be able to help you, please get in touch.