- Yes, you can borrow a million dollars and potentially only pay $20,000/year
- However, interest rates don't have a strong correlation with property prices
- ... according to analysis from PIPA
Almost every article this year about the ongoing property boom lays much of the reason at the door of historically low interest rates.
Commonly referred to as the ‘price of money’, the central bank cash rate has been at 0.1% since November last year.
It has never been that low before, and it shows no signs of being raised. The RBA is set on a course of driving unemployment down below 5% and will only countenance raising interest rates when wage inflation is in the 2% to 3% range. They believe this will not happen until 2023 or 2024.
So, in an era of cheap money, why not go out and borrow? After all, as one experienced real estate agent told me last week, “when you can borrow a million dollars and only have to pay $20,000 a year, why not borrow a million?”
Why not indeed. Home loan interest rates are as low as 2% now.
It’s not just interest rates
However, research over the past 20 years has shown that property price growth is “less dependent” on low interest rates than we have been assuming, according to the Property Investment Professionals of Australia (PIPA).
While the cost of borrowing has never been cheaper, when the cash rate is exceptionally low it means that the economy needs some extra financial stimulation, which has been the case pretty much since the GFC way back in 2008 and beyond,” said PIPA Chair Peter Koulizos, in a statement.
There are other factors at play, and these are stronger influencers of current property price growth, he believes.
“The current market conditions are unusual, given markets are rising in lockstep around the country, but this is predominantly due to extremely strong demand from buyers and a low supply of property for sale, rather than the fact that the cash rate is really only marginally lower than it was before the pandemic hit,” he said.
In other words, it’s good old fashioned supply (low) and demand (high).
Mr Koulizos’ analysis of the ABS’ ‘Established House Price Indexes’ for three periods over the past two decades when interest rates were stable found that low interest rates does not necessarily mean property prices rise.
Established House Indexes: Eight Capital Cities
For example, from September 2016 to September 2019, when the cash rate was just 1.5%, the weighted average across eight capital cities saw the established house price index increase by only 1.24% over the period.
Likewise, between September 2013 and December 2014, the majority of capital cities experienced moderate price growth at a time when the cash rate was 2.5%, which was an historic low at the time.
“What my analysis showed is that low interest rates don’t light a fire under property prices,” Mr Koulizos said.
“Sure, sometimes prices in some locations might start to strengthen at the same time as interest rates are low, but this is usually due to a number of other economic factors being in play, such as strong population and jobs growth, or simply more demand than supply.”
Perhaps we overplay the role of interest rates in the property market?