With Australian Interest Rates at historic lows, what are today’s rates or what do rates in general do to a property market and more importantly, the Australian property market?

I hope there are some readers here who remember the pre-GFC Standard Variable rates of 9%. Actually I might wheel my dad out who continues to ramble on about the 17% interest rates of the 80’s with the recession we had to have! He must have been truly scarred by that experience as I am sure many were who lived through that distressing period.

Do low interest rates lead to higher property prices?

Do low interest rates lead to higher property prices?

I’ll certainly be praying that we never return to those dark old days!

Now the Reserve Bank’s cash rate is at 2.25%, (www.rba.gov.au), and the good variable rates from reputable lenders are in the 4.5% range. Fixed rates are also fantastic and as we discussed previously the fixed vs variable option, keep an eye on what those fixed rates are doing.

On a simple note, when the RBA reduces rates, they are trying to encourage spending and ensure there is more money in the economy, therefore stimulating growth. When they raise the cash rate, they are trying to slow down the economy and remove funds so the economy can slow and they can maintain inflation at a reasonable level.

Lets discuss what interest rates do to the property market and if they do in fact influence things. Firstly, from an investor point of view, with a nod to Investopedia on how they feel rates affect investor purchasers, have a coffee before reading this as it is reasonably heavy:

Interest rates have a profound effect on the value of income-producing real estate as on any investment vehicle. (ie shares, managed funds etc)

The influence of interest rates on an individual’s ability to purchase residential properties, (by increasing or decreasing the cost of mortgage capital) is so profound, many people incorrectly assume that the only deciding factor in real estate valuation is the mortgage rate.

However mortgage rates are only one interest-related factor influencing property values. Because interest rates also affect capital flows, (ie the movement of money for the purpose of investment, trade or business production), the supply and demand for capital and investors’ required rates of return on investment, interest rates will drive property prices in a variety of ways.

Although real estate values are influenced by the supply and demand for properties in any given location, the “income approach” is the most common valuation technique for investors.

In its basic sense, the income approach is simply the rate of return you may receive for your investment. Ie after all costs, what will your rental return and capital appreciation be? (I hope people still care about this!).

Also keep in mind when there is more capital in the economy, and importantly the availability of capital, there should be a stimulation in capital works and property development.

Therefore it can be assumed, from an investor perspective, that lower interest rates do put upward pressure on property prices. Cheap rates and good rental return means properties becoming cash flow neutral or dare we say cash flow positive in a shorter period of time. So why wouldn’t investors get into the market and park their capital in the relatively safe property market?

So that is fine for investors when it is a cold blooded business decision but what about the owner occupiers who might act with their heart, rather than their head! What affect do rates have on them? There are many factors influencing owner occupied purchases and many are not financial. They could be lifestyle choices, family size increasing or decreasing, location change, work or any other number of reasons. None of these reasons are generally financial, ie what deposit do we have, what does our current cash flow allow us to pay back on a mortgage per month etc.

So although record low interest rates in Australia may be a bonus for owner occupiers, they may not have a direct influence on property prices. Indirectly though, there would be various reasons how they do place upward pressure on property prices as these owner occupiers then have to compete with investors and developers who are eyeing similar properties with cheaper funds to work with thanks to the RBA!

Interesting times ahead!