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Do rising mortgage rates trigger lower house prices?

While it certainly is true that higher interest rates increase borrowing costs, this generally happens in periods with higher economic growth, rising inflation, rising incomes, higher levels of employment and increasing consumer confidence.

House prices also fluctuate on supply and demand, net immigration and other economic variables.

The great bond bull market that started in 1989 ignited the great housing bull market we have witnessed since then. For a graphical visualisation see post on 6 December 2019 https://cls.com.au/news/what-your-great-grandparents-paid-for-their-home-and-home-loan-interest-rate

If you’re a homebuyer now you may be wondering if higher interest rates will lead to a drop in the home prices you are willing to pay today.

A house is a long-lived asset. The value of any such asset (real estate, stock share, or bond) is the sum of the future stream of cash flow or benefits, discounted by the interest rate. With higher interest rates, the discounting reduces the present value of those future income streams.

Let’s not discuss how can this logic be wrong but instead let’s do the arithmetic.

Today’s Reserve Bank cash rate is 0.75%.

The owner-occupied principal and interest repayment home loan variable interest rate is circa 3.10% and the investment principal and interest variable interest rate is circa 3.40%.

The median Sydney house price is $1,120,000 selling on a gross rental yield of 2.8%; and the median Sydney apartment price is $770,000 selling on a gross yield of 3.60%.

We have modelled that a 1% uniform increase in wholesale interest rates across the yield curve (from the overnight cash rate to 30 years interest rate swaps) will lead to a 12% drop in house price in order to maintain the same net present value of those future income (rental) streams.

Will this happen? Very unlikely. However, more likely if stagflation (a word forgotten in the annals of history) returns with a vengeance.

Author QED Realty

Dec 17th, 2019
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