The Impact of an RBA Rate Cut on Property Prices

Interest rates have fallen to 0.5% in the last 12 months after the RBA started cutting aggressively to combat weak economic conditions. So what does this mean for property prices going forward?

Australia’s interest rates are very quickly approaching zero after the RBA slashed the official cash rate to 0.5%.

Interest rates at these sorts of levels have not been seen for over 60-years and it is shaping up as a potential windfall for both property investors and homeowners.

However, it’s fair to say that 12 months is a long time in real estate in Australia as the start of 2019 we had a very different situation from the one we are seeing at the moment.

Only last year the official cash rate sat at 1.5% and the RBA had been sitting on its hands for more than two years. Over a five year period, many areas of Sydney and Melbourne doubled in value in what many thought was a then, low-interest-rate environment.

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Around that same time, the Australian Prudential Regulation Authority (APRA), had been clamping down on lending by requiring borrowers to meet higher a higher serviceability buffer – around 7.5%. These restrictions along with the natural course of the property cycle saw values ultimately slow down and even fall. The environment was also being impacted by the prospects of a Labor victory at the Federal Election which could have seen the removal of negative gearing tax benefits.

When APRA dropped it’s lending requirements and Scott Morrison became Prime Minister, the RBA also began to further ease interest rates.

Reserve Bank Decision

In quick succession, the RBA cut interest rates three times taking the cash rate to 0.75% and the impact on property prices started to be felt immediately.

In the last three months alone, property prices across the country have jumped with Sydney climbing 4.6% and Melbourne climbing 3.9% according to the latest data from CoreLogic.

Clearly, there is a strong correlation between low-interest rates and property prices, so what impact will low interest rates have going forward?

Low Interest Rates in 2020

Prior to the RBA getting stuck into its cycle of easing, a report from the RBA suggested that the immediate impact of cutting the cash rate would be rising property prices.

In the paper, it says that “a percentage point drop in the expected real mortgage rate would boost housing prices by 28 per cent in the long run”.

So far the cash rate has fallen from 1.5% to 0.5% and in that same period of time, we’ve seen house prices rise by 8% across the country, according to CoreLogic. That would suggest there is still clearly some more room to go – as much as 20%.

Those numbers also equate to what we saw during the last property growth cycle. During the 2012 to 2017 boom, the 50% increase in national prices came at a time that the RBA slashed the cash rate from 4.75% to 1.50%. This came during the period after the fallout from the Global Financial Crisis (GFC).

Increased Access to Credit

One of the obvious advantages of lower interest rates is the increase in the ability of people to borrow money.

After the GFC, global banks adopted new lending policies that required borrowers to prove their ability to service a loan. So banks will assess your income and expenses and lend money based on any surplus income.

One of the obvious factors that impact you’re expenses are interest rates. The lower the cash rate means lower mortgage rates and therefore greater borrowing capacity.

We’ve seen the same thing since APRA reduced it’s lending criteria. Previously a borrower needed the ability to repay up to 7.5% per year. Even at a time that interest rates were sitting at 1.5%. So they had been effectively holding the property market back.

As we continued with the era of low rates, property prices will continue to increase up until the point that median incomes are no longer able to service loans based on median house prices.

A Positively Geared Housing Market

In the current environment, borrowers are able to access mortgages with interest rates as low as 2.5%.

When we compare the current level of mortgages to gross rental yields across the country, we can see that most states will have properties where holding costs are lower than yields. This allows borrowers to access money easier and increases interest from investors looking to purchase property.

For example, average gross yields, based on dwelling values are at 5.9% in Darwin, 5.0% in Hobart and 4.5% in Brisbane and Adelaide according to CoreLogic.

So this will clearly continue to have a positive effect on property prices, particularly in the states and cities with already strong yields.

Lower interest rates also add to what is commonly referred to as the ‘wealth effect’. As low-interest rates boost demand for property, homeowners and investors fell more wealthy and therefore are prepared to spend more money which in turn boosts the broader economy and the cycle continues.

We also see real estate related jobs increase which has additional benefits. For example, higher prices make new property developments more feasible, which boost construction jobs.

Clearly low-interest rates will continue to make property an enticing proposition for both investors and homeowners going forward and keep upward pressure on property prices in 2020.

At the same time, low-interest rates in Australia will also boost other asset classes like stocks and bonds.

And if the RBA are to be believed, we will still likely see some more significant price increases for Australian real estate, before the end of the current growth cycle thanks predominately to low-interest rates.