Houses Divided

Beware of buying houses based on loan rate movements.

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Australian policymakers use lending rates to stabilise house prices. House prices are expected to move opposite to the interest rates charged by banks, which are set in line with the RBA's rates. When rates fall, borrowers can afford higher repayments, higher principal amounts, more expensive properties, and vice versa.

However, this has not historically been uniform.

Let's look at the correlation - the strength of the directional relationship - between (1) borrowing rates (2) and housing prices (3) in Australian capital cities. Negative correlations represent an inverse relationship while positive covariances indicate movement 'in line with'. The strongest correlations are 1 and -1. Numbers close to zero indicate weak to no relationship.

• Sydney (pop. 4504k): -0.52
• Melbourne (pop. 3995k): -0.48
• Brisbane (pop. 2004k): -0.24
• Perth (pop. 1658k): -0.18
• Adelaide (pop. 1187k): -0.20
• Canberra (pop. 420k): -0.40
• Hobart (pop. 212k): -0.32
• Darwin (pop. 124k): -0.09
• Weighted average: -0.54

As anticipated, house prices on the whole moved moderately opposite to rates, more so than any single capital city.

However, house prices in some capital cities, notably Perth and Darwin, display a very weak negative correlation to rate movements. Prices may shrug off rate movements, or even move with them, rising as borrowing costs rise, or falling despite cheaper money. 

Why might this be so?

It's possible that rate movements influence capital flow from one market to another. For example, while higher rates may prompt investors to withdraw from big cities, that money has to go somewhere instead, perhaps to higher yield alternatives like Adelaide or Brisbane, cushioning the market.

I think it's more likely that there is some element of rates responding to prices instead of the other way around. Policy makers target Sydney and Melbourne, home to over a third of Australia's population, placing a lower priority on booms or busts that may be happening elsewhere in the country.

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For those in the market, it's another reminder that Australian housing is divided geographically, and that outside the two major capital cities interest rate movements may not have the expected dampening or boosting effect.

Postscript: Buy the Market

Could you hold a property portfolio that resembled the weighted average, presumably making the effects of rate changes or price rises more predictable? 

Theoretically yes, but it would be expensive. You'd need one house in each of Hobart and Canberra, three or four in each of Adelaide, Brisbane, and Perth, and finally six or seven properties in each of Sydney and Melbourne.

This would not be a problem if houses were dirt cheap, but most people need to borrow heavily to afford just one, hence their sensitivity to interest rates. Owning 23 properties may be heavenly, but owing 23 mortgages is hellish. Diversified direct property investment is out of reach for the vast majority. 

1. Quarterly year-on-year residential property price index changes compared with standard variable owner-occupier loan rate changes for the same period, September 2004 to September 2020
2. RBA Series F5 - Indicator Lending Rates
3. ABS Residential Property Prices