We all fear inflation, the economic force that makes goods and services cost more each week. Steadily eating away at the dollar’s value.
Inflation sounds scary and is somewhat inevitable, but can it be a good thing? There are some assets like property that can benefit from rising prices. However, the RBA’s favourite way to manage inflation is to tinker with interest rates. And that may not be so good.
How does interest affect house prices, and how much influence should it have over purchasing a new home or an investor’s real estate strategy?
Property and inflation?
There are hundreds of variables that influence how much inflation an economy experiences. The more money circulating through an economy, the more value available assets will have.
Say Australia was a tiny island nation with just 20 houses built exactly the same. There were no other assets to invest in, and the entire economy had $2000.
In such an economy, each house would be worth $100 (2000 divided by 20 =100). Now consider if the central bank of this tiny island nation injected another $2000 into the economy. The number of available assets is unchanged, but there’s more money to chase. The value of each home will now be worth twice as much, or $200.
Of course, many more factors are at play in the real economy. For example, the above scenario does not factor in interest rates, which is a strategy the Reserve Bank of Australia (RBA) often uses to rein in inflation.
Inflation, Interest Rates, and Property Prices
As we know from the example above, the more money available in an economy, the higher asset prices can go. Increasing interest rates limits the amount of funds people have to spend, effectively siphoning money out of the collective economic pool.
Interest rates influence supply and demand, which in turn affects property prices. Low-interest rates make finance more affordable. There is an influx of buyers, and when demand outpaces supply, homes increase in value. The key here is supply and demand. There are many other issues that will continue to put pressure on supply, such as trade availability, population growth and wage growth.
The RBA will attempt to curb protracted periods of inflation by increasing interest rates. A higher interest rate means more expensive financing, a potential reduction in buyers, and a slower pace for inflation because there is less money to spend on goods and services.
Will Australia’s Property Market Crash Any Time Soon?
The Australian housing market has proven resilient against market forces. While house prices sometimes fall by a small margin during interest rate hikes, they rarely drop by more than a few percentage points. And it’s often short-lived.
If there is supply pressure, even high-interest rates may not curb growth. For example, between 2002 and 2004 in Australia, interest rates ranged from 7% to 8%, and the market grew by 12% to 15%.
From 1991 to 1994, interest rates hovered around 10% to 12%, but the property market still trended upwards marginally.
Investors can find excellent opportunities during periods of high inflation. Challenging financial conditions mean more people rent to keep a roof over their heads. Growing demand for rentals amid a dwindling supply of homes increases rental yields.
You undoubtedly saw headlines predicting a dire future for the property market during the pandemic. Still, it didn’t play out as many expected it would. Rather than experiencing a property crash, many landlords discovered rental properties were in high demand. Rental prices skyrocketed to create an Australia-wide housing crisis.
In 2022, many who succumbed to the market fears and sold early in the pandemic discovered they had sacrificed hundreds of thousands of dollars as rental supplies plummeted and properties increased in value.
We have seen time and time again the Australian property market thumbing its nose at the naysayers as it continues to deliver sound investment opportunities. Yes, it’s wise to keep your eye on current prices, but it’s more critical to consider the value of your portfolio 10 or 15 years from now. A few dips along the way aren’t going to matter too much to the long-term investor.
We believe a moderate interest rate increase is unlikely to have much of an impact on house prices for the foreseeable future. With a supply chain in tatters and mounting construction delays, building new homes is more challenging, time-consuming and expensive than a few months ago. As a result, the supply of properties will continue to be limited, which should help keep prices stable.
We know that dips are expected, but the trend is invariably upward when you buy and hold for decades. If you are looking for advice on maximising your gains or finding the best property market for your investment style, call today to learn how you can secure your financial future.