Some media reports have claimed that the Reserve Bank of Australia (RBA) has predicted a 15% fall in house prices, but in a speech at the AFR Property Summit in Sydney this week, RBA head of domestic markets Jonathan Kearns said that is not strictly accurate – and that interest rates are not the only influence on the market.
“News coverage and the proverbial barbecue conversations seem to either fret that prices are rising too quickly, or that they are falling. The other popular topic in the news – particularly at the moment – is interest rates. Perhaps not surprisingly, there are important connections between property prices and interest rates”, Kearns said.
“In the April (Financial Stability Review), we used a user-cost model to estimate that a 200-basis-point increase in interest rates…would lower real housing prices by around 15% over a two-year period,” Kearns said.
“While this 15% decline was commonly reported as being a forecast for housing prices, it was not actually a prediction of how much housing prices would change. Rather, it was an estimate of how sensitive housing prices are to interest rates, assuming that all the other costs and benefits to housing don’t change with interest rates.”
Kearns believes many factors other than interest rates influence housing prices.
“For example, the demand for housing would be greater with stronger household income growth, increased population through immigration, or a preference for fewer people living in each household”, he said.
“Conversely, the supply of housing would be lower than expected if construction turns out to be constrained in some way.
“These factors would all lead to stronger demand, or weaker supply, for housing, and so housing prices – and rents – would not fall as much as implied by interest rates acting in isolation.”
Kearns also holds that the impact of rates on housing prices isn’t just determined by how much rates change, but for how long.
“If interest rates were assumed to be 200 basis points higher forever, then this model suggests that housing prices would end up being around 30% lower than if interest rates had not changed,” he said.
“It is notable that these estimates based on historical data show that the change in housing prices occurs relatively slowly – certainly more slowly than for the prices of financial assets.
“This model also suggests that if interest rates reverted to their initial level after that two-year period, the interest rate effect on prices would be expected to eventually unwind.”
Kearns also believes that while rising interest rates initially increase the cost of owning a home in the short term, they actually work to reduce demand and make homeownership less expensive.
“Estimates suggest that the net effect is that mortgage payments for new buyers would be higher for about two years as a result of higher interest rates,” he said.
“But after that, the declines in housing prices and mortgage size begin to dominate. This exercise obviously abstracts from the many other factors influencing interest rates and housing prices, but it suggests that because higher interest rates reduce housing prices and so mortgage sizes, mortgage repayments for new borrowers could ultimately be lower than if interest rates had not increased.”
In conclusion, Kearns said that the response of property prices tends to be drawn out, occurring over years rather than months, and so given other drivers of prices also change in the interim, it is difficult to disentangle the final impact on prices of changes in interest rates.
