Here's how higher interest rates will affect the housing market

What is happening to interest rate?

The Reserve Bank of Australia's decision to increase interest rates could have an impact on property development in the country. Property developers typically rely on borrowing money to finance their projects, and higher interest rates can make it more expensive to borrow. As a result, the RBA's decision may make it more difficult for property developers to obtain financing for new projects. In addition, higher interest rates could also discourage potential home buyers from taking out mortgages, which could reduce demand for new properties. As a result, the RBA's decision to increase interest rates could have a significant impact on property development in Australia. It was the third time that RBA increased interest rate since May. It was raised from a record low of 0.1 per cent to 1.35 per cent now.

The increase in property development activity in July is a further step in the withdrawal of the extraordinary monetary support that was put in place during the pandemic. Now, the main objective of interest rate tool is to contain the high inflation. The property market had been one of the hardest hit sectors of the economy during the pandemic but has started to bounce back quickly as the vaccine rollout continues. The rapid increase in prices is likely to continue in the short-term as demand continues to outstrip supply. However, the central bank is expected to start withdrawing support later this year as the economy continues to recover. This will eventually lead to higher interest rates and slower property price growth.

What is the interest rate outlook?

The property development industry is closely watching the movements of the Reserve Bank of Australia (RBA), as it is widely believed that the RBA will continue to increase interest rates in the rest of 2022 or in 2023. This would have a flow-on effect to property developers, who would likely pass on the higher costs to consumers in the form of higher prices for new developments. This could put a dampener on the property market, which has been showing strong signs of growth in recent months. However, it is worth noting that the RBA has said that it will not increase rates until inflation is back to its target range of 2-3%. This means that there is still some time before rates are increased, and property developers will be closely monitoring the situation. Major financial institutions have made predictions about the interest as shown by the table below.

How does the increasing interest rate affect housing market?

Rising interest rates can have a major impact on the property market, both for buyers and sellers. For homeowners who need to take out a mortgage to purchase a property, the increased interest rate will result in higher borrowing costs and reduced borrowing capacity. Even for investors who purchase homes with cash, higher interest rates will increase their expectations of investment return and reduce their willingness to pay at a certain price level. This can lead to slower property development and lower prices for finished properties. While this may be good news for buyers, it can put pressure on those who are looking to sell their property, especially if they need to sell quickly. As a result, it is important to be aware of how changes in interest rates can affect the property market before making any decisions.

As shown by the graph above, Australian homeowners have been enjoying a declining interest rate since the pandemic and furthermore, a record low interest rate of 0.1 per cent since November 2020.

RBA has noted that Australia's capital cities have seen their residential property markets experience a significant upswing in prices due to the low interest rate. This has been a boon for property developers, who have been able to take advantage of the low interest rate environment to buy and develop property at record prices. However, there are concerns that the property market is becoming overheated, as prices continue to rise faster than incomes. This could eventually lead to a sharp correction in prices, which would negatively impact property developers and homeowners alike. As such, it will be important to closely monitor the property market in the coming months to ensure that it remains healthy and sustainable.

The Reserve Bank of Australia's decision to increase interest rates three times in as many months is widely seen as a reaction to the booming property market. While property developers and investors have welcomed the RBA's actions, first-time buyers and those with variable-rate mortgages are feeling the pinch. The RBA has said that it is concerned about the potential for a housing bubble, and that its goal is to cool the property market while keeping inflation under control. However, some commentators have criticized the RBA for acting too late and warn that further rate hikes could put a strain on the economy. Time will tell whether the RBA's rate moves are successful in moderating the property market.

How far could higher interest rate impact the housing market?

In 2019, the researchers of RBA built an empirical model of the Australian housing market that quantifies interrelationships between construction, rents, prices and interest rate. Based on this model and the widespread belief that more interest rate hikes will occur over the coming months; we can predict the influence of higher interest rate on housing market in a more quantitative manner. For example, property development is usually more sensitive to changes in interest rates than already existing property. This means that developers may be less willing to undertake new projects if interest rates increase, leading to fewer new properties being built. This in turn could lead to higher rents as there is less competition from new developments, and eventually prices may also rise as demand for property outstrips supply. However, it is important to note that these effects will vary depending on local market conditions. Nevertheless, the RBA's model provides a useful tool for understanding how changes in interest rates could affect the housing market in diverse ways.

If we assume RBA will increase the interest rate to 2.1 per cent by the end of 2022, the following conclusions could be made from the model.

·????????Housing prices will decrease by approximately 15 per cent in the next two years.

·????????Rents will decrease by more than 1 per cent in the next two years.

·????????Dwelling investment will decrease by approximately 15 per cent in the next two years.

·????????User cost of housing will increase by 1 per cent in the next two years.

Besides our inference from an ‘academic’ perspective, major banks also provide their prediction from the industry view. According to Gareth Aird, Commonwealth Bank head of Australian economics, house prices across Australia will drop by 15 per cent over the next 18 months. He predicted that Melbourne would experience a 10 per cent drop over the rest of this year and another 8 per cent decline in 2023. He also predicted an 11 per cent fall in Sydney house prices this year, followed by a further 7 per cent drop next year.

What is RBA’s attitude toward housing market?

According to the RBA’s latest minutes of the monetary policy meeting published on 19th July, it has been noted by RBA board members that housing prices had declined in some cities in recent months. In Sydney and Melbourne, turnover and clearance rates had declined, and the number of properties listed for sale was higher than over recent years.

In RBA’s statement of June, it is also acknowledged that housing prices have declined in some markets over recent months but remain more than 25 per cent higher than prior to the pandemic.

We think RBA has been fully aware of the overheated housing market. RBA’s recent rates move will have a chilling impact on the market, especially in the era of post pandemic.

Jacky Cui

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