How about that rate cut?
Australian property market prices are falling, and rents are rising rapidly. Interest rates are rising even faster at the headline. But, last month at least, banks actually cut rates to many customers:
The gap now between standard and discounted rates is higher than it has ever been:
And that doesn’t tell the full story. Jump on to any home loan comparison site, and plenty of home loans are available at rates lower than the RBA’s discounted standard variable rate. While the average discounts appear to be 1.4%, discounts well over 2% seem to be frequent. Some discounts are closer to 3%.
So, bank competition remains high. The “standard” variable rate is looking more and more like the sticker price on a used car. i.e. it is a rate that very few people actually pay.
For my numbers, I use the minimum of the owner-occupied variable rates and the 3-year fixed rate. Which means that affordability improved a little by my numbers. Although affordability is still terrible in most housing markets.
What matters more – the level of interest rates or the change?
Another way to look at the shock to the Australian economy is to measure the amount of interest paid as a proportion of the gross domestic product:
Both of these perspectives matter. The overall burden is important, but it is usually the rate of change that creates crises. This time around, the rate of change is overstated, as there is a greater than usual number of home loan customers on fixed rates. But that will delay the issue, not solve it.
The shock to the Australian economy through interest rate rises will be higher than we have ever seen before.
Australian property market prices are falling, and rents are rising rapidly. Interest rates are rising even faster. Affordability statistics have diverged quite sharply between houses and units. The affordability of houses is as poor as it has ever been. The affordability of units is below average, but nowhere near as bad as houses. This is likely reflecting:
- a change in living preferences following the pandemic
- the effect of lower population growth (particularly students) over the last few years
Affordability was already as poor as it had ever been in some markets before the rate rise.
Housing valuation and affordability statistics improved over November, but are worse over three months. For investors, rental yields improved a little as rents rose while prices fell. But yields are still very low vs history, and interest rate rises would have swamped any gains for investors looking to borrow.
What are the limits to house prices?
Valuing the overall housing market is difficult given the rise in Australian house prices over the last 30 years. But there are limits. If house prices grow at 10% p.a. for the next 20 years, and wages/rents kept going up at their historical rates then:
- The median Sydney house price would be over $7m
- The median Sydney house price would be 45x higher than the median wage.
- Even if you managed to scrape together the 5% deposit (only twice the median annual pretax salary) to qualify for a 95% mortgage, the mortgage payment would come in at almost 3x the median pretax salary
That is not a realistic vision of society to me. So, we created an Australian property market calculator to help investors or potential homeowners determine the returns on Australian property. The idea we want to illustrate is that there are a number of key inputs into housing valuation. Interest rates are the most important, but the other limiting factors are:
- Mortgage Payments to Rent: comparing the cost of a mortgage with the cost of renting the same house. Using this ratio to constrain house prices, we assume that people will prefer to rent when the ratio gets high rather than buy.
- Mortgage Payments to Wages: assuming when the ratio gets high, people rent because they cannot afford to buy.
- Property Prices to Wages: assuming when the ratio gets high, people rent because they cannot save enough money to afford a deposit. We treat this as less important than the above two ratios.
- Rental Yield: Rental yield is the annual rent divided by the property price. By using this ratio to forecast prices, you are assuming when the ratio gets low investors will not buy property as they are not getting a return that is high enough.
Detailed charts for the above locations can be found in the property detail update. For more on how and why we use these ratios see our residential real estate forecasting methodology.
Waiting for the effects of rate rises
The delay in interest rate impacts on the Australian economy is in four parts:
- Delayed direct impact of rate rises. Typically rate rises take 2-3 months before affecting cash flow for a borrower. i.e. only 0.25-75% of recent increases have actually been felt by borrowers.
- Delayed effect due to greater than usual concentration of fixed-rate mortgages. In March 2020, the Reserve Bank also introduced a facility where they lent directly to the banks at 0.1% for three years. This facility (and other market interventions) allowed banks to drop three-year fixed mortgages to around 2%. In response, fixed mortgages went from 10-15% of refinancing to over 40%. These will roll off, but in the interim, there are far more people who will be unaffected by the rate rises until they refinance.
- Delayed indirect impact of rate rises. From the 3 months, for borrowers to actually notice and change spending patterns. So, for businesses that rely on consumer demand, it can take another few months before the effect flows through.
- Delayed 2nd order and above effect. The economic multiplier compounds the effect for months going forward. i.e. consumers spend less (say) on eating out which means that restauranteurs have less money to spend and then may lay off staff who also reduce spending. The effect of this echoes multiple times through the economy. Typical estimates suggest 1-2 years for changes in monetary policy to have the full effect.
The net impact is that the valuation ratios we have included in this report reflect the latest interest rate hikes announced by the central bank. The economic impacts, and the impact on house prices, are largely yet to come.
When you adjust the factors in our property market calculator, you find that with higher interest rates, you would have to put in never-seen-before valuation ratios for house prices not to fall.
Australian Property Market Outlook
Property prices have clearly started to fall in the more up-to-date data. Interest rates now rapidly rising and the RBA is talking about more.
In my view, rising rates will trump the other factors, but many opposing forces are at play:
On the one hand, property developers are falling over left and right, caught between rising costs and fixed-price contracts. Rental growth jumped again this quarter, but the last few years have been very weak. And Australia starts with a larger private debt burden than just about any other country.
On the other hand, we have a burning political desire to keep Australian property market prices high and pump more debt into the economy. Wage growth is low, meaning the interest rate rises that the market is pricing may not eventuate. There is a structurally higher demand for houses vs units due to the fear of more lockdowns. There is a structurally higher demand for bigger houses, more rooms or fewer housemates given the move to work from home.
Rising rents and falling prices are usually a sign to start looking at the property market. But with the speed of the interest rate rises already and more to come, it is likely going to be more prudent to wait. Keep in mind that interest rates take some time to take effect. If the RBA is wrong then they might not realise it before a recession is already here. The most important issue right now is interest rates. Can the Australian economy withstand a 4% of GDP change in the amount of interest paid?
Nucleus Wealth has compiled this data using a range of different sources.
We use Domain for more recent data quarterly property prices and rents, cross-checked with SQM to fill any short-term moves. Older information is from Rismark and the Australian Bureau of Statistics to fill time series.
For economic data, we use either Reserve Bank of Australia or Australia Bureau of Statistics data. For older data, we have had to estimate some factors due to differing definitions over time.
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The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Nucleus Advice Pty Ltd – AFSL 515796.