What an increase in the cash rate will do to property prices

What an increase in the cash rate will do to property prices

The official cash rate has increased to 0.85%, with most expecting the rises to continue. Whenever interest rates rise, most of us think about how it will affect housing prices. And it is no wonder, housing makes up more than $9.5 trillion of our nation’s wealth. Superannuation, by comparison, is worth $3.5 trillion and Australia has the 4th largest superannuation pool in the world. I suspect we are the most real estate centric nation on the planet.

But what do changes in the official cash rate mean for property prices?
1% increase translates to about a 15% fall in property prices. They’re not my figures, they’re Christopher Joye’s, and I’ve linked a recent article he wrote if you want to get into the detail.


Christopher’s premise is that we are far more sensitive to interest rate rises than the RBA’s own modelling suggests. This is coming from someone who worked for the Reserve Bank, runs one of the most successful investment firms in Australia and employs more people with PHD’s in Mathematics than any other qualification. He has also been annoyingly right with his predictions of property prices for longer than I can remember. If you are betting on real estate, his opinions are a lot sounder than most of the banks’ economists, I suspect. And as I understand him, this is the short version of what he thinks will happen.

If the cash rate rises between 1-1.5%, property prices will fall between 15-25%. It sounds terrible, but I don’t think all that pain will be shared evenly, at least not in our area.

Short history summary.
In January 2017, the average asking price of a unit was about $785,000 (there were a lot of new units on the market). At the same time, the average asking price of a house was $1,273,000. The price ratio between the two was roughly 40:60. Putting it another way, if you had to pay $1 to buy a unit, you would have to pay $1.50 to buy a house. That price ratio between units and houses has been around for quite a long time and up to then had been pretty stable. At least that was the case until recently.

In January this year, the average asking price of a unit was $734,000 (yes, it had gone backwards), but a house had risen to $2,067,000. That relative value was now close to 25:75. Again putting it in dollars, if a unit cost $1, a house was close to $3. The market for houses had taken off while the unit market did nothing. There are lots of reasons why houses did better than units. Overbuilding of units and rental returns crashing are two of the biggest. Now that divergence between the unit and house markets seems to be correcting.

According to SQM research, the asking price of houses in our area has dropped 6.6% in the last three months. For units, that drop is just 0.3%. It is not a large disparity, but it is enough to show how interest rates are impacting the unit and house markets differently.

For the last five years, unit buyers have been predominately owner-occupiers. Investors who generally made up 50% of unit buyers before 2017 dropped back to about 20% of unit buyers between 2017 and now. Investors haven’t returned yet but that may not be too far off.

Vacancy rates in our area are now under 2%, and that is the first time since 2017.

As vacancy falls, rents increase. Rents that fell during Covid are coming back up to pre-Covid levels. If things keep going as they are, we could see investors buying back into the unit market and unit prices climbing even as interest rates rise.

How long might that take? I think by the end of this year.

Author – Stephen Jackson