What rate cuts could mean for your investment property
Own an investment property or looking to get into the market? Find out how the impending interest rate cuts could affect you.
With this year’s rate cuts across two large institutions, the US Federal Reserve, Bank of England and European Central Bank, local focus turns to the RBA as the world begins its pivot to loosening monetary policy.
This calls to question whether we will see the RBA’s ever present poker face show some movement at the next interest rate announcement earlier November.
None of the four major banks anticipate a rate cut before December 2024 at the earliest – NAB even predicting that the first rate cut won’t come earlier than May 2025.
In the midst of this, it appears house prices have been largely immune to fears of an interest rate-influenced housing slump. Given the uncertainty in the monetary environment, property investors must be prepared for what potential rate cuts could mean.
The RBA’s recent Financial Stability Review released in September found that most borrowers have strong equity positions, protecting them from default and limiting lenders’ potential losses. However, heed a warning that “resilience could be eroded if households respond to any actual or anticipated easing in financial conditions by taking on excessive debt”. Falling interest rates and excessive individual debt levels have historically coincided, with some lenders expanding credit to riskier borrowers.
Despite decade-high interest rates, statistics show that house prices now are higher than when the RBA raised interest rates in May 2022, the first covid related rate hike that was followed by subsequent tightening measures.
Source: CoreLogic. September 2024.
Australia's property dynamics
The majority of wealth (~58%) in Australia is currently comprised of owner-occupied housing and investment properties, with superannuation and financial and non-financial assets trailing behind at 21%, 12% and 9% respectively.
The Australian Tax Office (“ATO”)’s latest data available (2020 – 21) uncovered that around 20% of Australian taxpayers owned at least one investment property, and of this group, 29% owned more than one.
With this overarching sentiment, it is not surprising that there is enhanced focus on individuals looking to get into the property market. Earlier generations have largely built wealth through property ownership and there is a clear trend of younger individuals seeking to replicate that. Data by the Australian Bureau of Statistics shows lending to investors continues to rise with loan values ~36% higher compared to a year ago.
Source: Australian Bureau of Statistics. April 2024.
Ongoing housing crisis
Lower rates are generally correlated to increased demand for properties which drives up prices. Traditionally higher rates cool down the market. We saw this during the rate hikes between 2022 - 23 when housing prices cooled down for a few months. However, this was short lived as prices inexplicably picked up again at the beginning of 2023 despite consistent increases in the cash rate.
The Australia housing crisis is characterised by a complex web of factors that may explain the price appreciating despite higher rates. The intricacies of our economy are not solely attributed to interest rates, the local supply and demand dynamics play a huge role in determining the current housing environment.
Underlying demand for housing is fundamentally determined by the size of population and average occupants of each dwelling. The current crisis is widely attributed to persistent supply issues, surging demand and therefore prices, as well as low rental vacancy and insufficient new builds to accommodate population growth led by overseas arrivals.
These supply issues were borne by a combination of labour shortages, rising construction costs and industry insolvencies creating a melting pot of issues, unable to meet the stream of net overseas migration which comprised 83% of last year’s population growth.
The construction industry has seen some significant headwinds such as materials scarcity and an acute labour shortage leading to a rising cost of materials and a premium on skilled trades such as steel fixers. There has been a steep decline in new house construction exacerbating the supply issue and appreciating existing dwellings even further.
It also appears like planning bureaucracy may be suffocating housing supply. The Building Council of Australia has suggested an overhaul of planning laws that include stripping local councils of their power if they consistently underperform in development assessment timeframes. ABS data shows a nationally consistent decline in housing approvals since its peak in mid-2021. Only 163,000 homes were approved in the last financial year falling more than 30% short of the Housing Accord target.
The NSW Government has introduced a State Significant Rezoning Policy establishing a pathway for identifying and assessing land for rezoning proposals, cutting timeframes and trying to address the crisis. However, BCA Chief Bran Black has stated that despite this, construction headwinds will still cause difficultly with execution.
Negative gearing policy has also been on the radar as Labor recently raised then seemingly snuffed discussion around the topic. The Green’s policy at the previous election suggested restricting negative gearing to only one investment property, then phasing it out for properties who have already been negatively geared over a five-year period. However, Labor has since ruled out revisiting negative gearing and capital gains tax concessions.
So how does this affect your investment property?
Lower rates reduce the cost of borrowing making it cheaper and easier for individuals to enter the market, find new purchases or refinance existing loans. The issue is that this benefit is not solely to existing investors, as barriers to entry into the market are lowered overall. Consider this a theoretical double-edged sword in the sense that lower rates attract more buyers, increasing competition for properties. I say theoretical, because as we have seen in the market, the inverse of this assumption hasn’t held true. Despite the current 4.35% interest rate, house prices continue to appreciate, and buyers have shown resilience in the face of RBA’s rate hikes.
The key takeaway may be herd mentality. The continued signals from the RBA to cool down inflation by raising rates stand little chance against a rush of individuals arguably transcending rationality for a chance to enter the market. Undoubtably, the Australian housing market is privy to a lot more influences that purely rates. The question is whether the increased property demand from lower borrowing costs will be met with adequate supply.
At the moment the answer reverberates as a resounding no. What this means as an existing investor is that one may see further price appreciation in the near term. Lower barrier to entry in the form of rate cuts may continue to fuel the supply squeeze as the construction industry struggles to catch up.
Whilst often in the hot seat, the influence of immigration may not be as impactful on the supply crunch. Census data showed that recent arrivals represented only 7% of homes purchased in the decade ending March 2023. Younger generations are increasingly exposed to the wealth that property ownership has generated for mature investors over the past few decades. Rate cuts will likely lead to an influx of wide-eyed new entrants hoping to buy their own slice of prosperity pie. The RBA has highlighted the risk of households taking on excessive debt, warning that it could lead to a substantial market correction that could deplete equity buffers and result in broader economic disruption.
If you’re considering your first investment property this article highlights our best resources to guide your decision.
