Don’t Buy At The Peak, Interest Rates Have Bottomed

Why We’re Booming? Affordability Up $110,000

As we outlined in our 2014 Property Forecast today’s property market is being driven by improved affordability thanks primarily to a sharp decline in interest rates, and in Sydney where income growth has over the last few years outstripped house price growth.  The CBA Affordability Index (last released Sep-13) highlights that the fall in interest rates since Sep-11 has led to an 18% or $549 per month fall in the monthly mortgage repayment.  This is a saving of $6,588 each year or put another way an increase in borrowing capacity of $109,800 (at 6% cost of funds). No wonder investors feel comfortable to stretch for that previously unaffordable investment property.

Just Focus on Interest Rates

If you’re uncertain over the future direction of the market, we suggest to just focus on future interest rate movements. The RBA recently (Feb-14) showed that property price growth generally follows mortgage rate movements. Note the mortgage rate show below has been plotted forward six months obscuring the fact that interest rates are a leading indicator. 

As can been seen from the chart below other factors also influence price growth as was evident in the lead up to the GFC when price growth was increasing even though interest rates were also ratcheted up. Little could slow down this once in a generation boom.  Since then interest rates and property price growth have been in step.  Price growth appears to respond to changes in interest rates and responds proportionately to the severity of the change. With this in mind let’s look at when the next change will occur and how great a shift it will be.

So Where Are Interest Rates Headed?

If interest rates are a strong leading indicator and have been responsible for a lot of the current boom then the obvious question is where are they headed.  According to the ASX cash rate futures the cash rate will start rising from its current level of 2.5% to 2.915% by August 2015.  This may seem a long way off but it was only a few months ago that a lot of economists were still forecasting one or two more cash rate cuts in 2014. Now we’re being told they’ve bottomed. This shift is significant as it signals we’re potentially entering a new phase of the property cycle.

These forecasts are supported by Australia’s best economic forecaster Bill Evans (according to a Bloomberg study) who updated his forecasts on 17 Mar 2014 from two rates cuts in 2014 to none in 2014 and two increases in 2015. This shift was driven by an improvement in the prospect for jobs growth. From the last six months of 2013, which were the weakest from a jobs growth perspective since the early 1990s, to a solid lift in growth in the first few months of 2014.  Mr Evans expects Melbourne and Perth housing markets to cool in 2014, while SA and Tasmania will be contained by structural challenges. He says that “it is only in Sydney where income growth has outstripped prices that further "catch-up" is likely”.

While interest rates remain at 2.5% during 2014 we suspect the Australian property market, particularly Sydney, will continue its impressive growth. The risks however increase substantially the closer we get to 2015.

We suggest caution if you’re only arriving to the property party now as getting in at this stage of the cycle certainly isn’t without risk. When interest rates have bottomed at 50 year lows and are forecast to increase, we suspect property prices are now close, if not at their peak.