Interest rates’ new regime

No rate rise today but one is likely soon. Some sectors of the property market will cool, but residential prices remain subject to strong demand and tight supply.

There was no interest rate rise announced today but economic analysts are still tipping there will be one, possibly two, rate rises before the end of the year, but what effect will they have on the property market?

The effect differs according to the market sector. A marginal increase of 0.25% always has some impact on the “fringe affordability” market, typically the highly geared first home buyer. A third or fourth rate rise over a relatively short period, with the prospect of more to come, has a greater impact across the broader markets.

Second home buyers in the higher-value range (those with more socio-economic horsepower), and property investors – in residential, retail, commercial and industrial – would now be re-doing their arithmetic and, when considering where rates may go in the short to medium term, could be pulling back a little.

I think there is a growing realisation among buyers that a higher-rate regime is emerging. This will ultimately change the thinking of broader property investment analysis, lifting the benchmark for internal rates of return the impact of which – everything else being equal – will be to reduce capital value.

If this happens, the smarter institutions and superannuation funds will be adjusting their acquisition strategies in accordance with some probable cooling in the market.

Notwithstanding the inevitability that interest rate rises building one upon another begin to erode real estate optimism, I believe that in the broader sense the Australian domestic real estate markets, particularly the residential sector, is unlikely to have any major adjustment.

There are too many trends moving the other way, such as the pressure of population growth, the demand for housing, the lack of supply, tight vacancy rates, and increasing rental levels. Combined, they outweigh concerns about interest rates and have the net effect of still driving the markets.

Rate rises now may have a patchy or occasional impact in particular circumstances, but broadly the market will take such increases in its stride. Of course, as in past cycles, there is a point at which interest rates can rise so significantly that the markets come tumbling down.

But who seriously contemplates this in the current strong economic cycle and with the better economic management that we now have both in the public and private sector.

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Comments

L. Stevens writes: I hope you are right but I also seeing people living and borrowing way beyond their means. It can’t last. And there is always one interest rate rise that tips the balance. Will the next one be the one? (Posted 4 April 2007 5.10pm)