Do rising mortgage rates depress price appreciation?

by Alistair Helm in ,


Just last week I undertook a detailed analysis of property sales and property prices for the past 20 years and matched them to the movements of mortgage rates in the article "Mortgage rates on the up - what will be the reaction of the property market?

A comment on that post raised my interest:

Hello Alistair
I refer to your graph entitled Rising mortgage rates generally depresses price appreciation.
I contend that the data indicates that for the first 3-4 years of the 5 year period displayed, median prices continued to increase, perhaps conservatively by 10% year on year. I don't have the raw data but it would be very interesting to overlay the 2 data sets and create a single line.
My point is this. The Reserve Bank just started increasing rates from all time lows. Historically your data indicates approx. 10% median increases in property prices for 3-4 years thereafter. So my conclusion is the opposite to yours, and price appreciation will occur, to the tune of 10% p.a. over the next 3-4 years in the absence of any major economic setback. Factor in Improving employment, Canterbury rebuild and Chinese investment and you have a glass half full situation in my opinion (if you own real estate).
Regards
Raefe

The graph to which he refers is this one tracking the periods of 1994 to 1997 and 2003 to 2008. My contention as I stated in the article was that during these periods when mortgage rates were on the rise property price appreciation was depressed. Not that prices fell, just that price appreciation was curtailed.

As per the recommendation of the writer of the comment I have redone the chart to align the two periods on split axis.

I would agree, that the fact is, that given the historical experience of mortgage interest rates being raised whilst property prices have been growing at a reasonable rate the impact is not to instantly depress price appreciation, rather as the chart would seem to indicate the market adjusts. 

It is possible to argue that the reaction of the market is to mark-time for the first year as interest rates are raised, then adjust to a lower rate of appreciation for anything from 2 years to 4 years - that is all the data that is available.

Apply this analysis to the current market it would be possible to support the writer of the comment and suggest that the likely trend in prices is to see a continuation of the current rate of price appreciation of c.10% per annum for the next 3 - 4 years.


Mortgage rates on the up - what will be the reaction of the property market?

by Alistair Helm in , ,


Last week we witnessed the first increase in the OCR since July 2010 when the rate was then raised from 2.75% to 3.0% - that change was short-lived as in March of 2011 it was dropped to 2.5%; a level it has maintained since. 

The fact is that the current levels of interest rates, which have been pretty much stable for the past 5 years represent an unprecedented period of low interest rates. A quick look back in history shows exactly how the past 5 years contrasts with the volatility of the past 50 years.

Historically mortgage rates have experienced typical cycles of rises and falls, especially over the past 25 years, with rates topping 20%+ at the end of the 80's. To put that into perspective a 30 year mortgage for a median priced $415,000 property which today based on an 20% deposit costs $1,948 per month would cost $4,198 at 15% mortgage rates and a staggering $5,684 per month if we were to experience the 20.5% mortgage rate of June 1987 again!

We are certainly going to have to adjust our expectation as mortgage holders to paying more a month in the coming years as the trend is upward. The recent 0.25% increase added $53 to the monthly cost of a 30 year mortgage of the median priced house.

Of equal concern to most home owners with a mortgage is the likely impact these rises in mortgage rates will have on the property market, both in terms of levels of activity and price.

Whilst data from the Reserve Bank on interest and mortgage rates goes back 50 years the data on property sales and prices from the Real Estate Institute only goes back 20 years, however the past 20 years does provide us with some valuable data as to the property cycles of the period for analysis.

The chart above tracks floating mortgage rates since 1992 and as highlighted by the coloured sections, this timeline does showcase some parallel periods of rate changes which can provide a basis for analysis.

Rising interest rates - The red sections "A" - this occurred between March 1994 and September 1996, a period of 31 months.  A similar rising interest rate period was from October 2003 to July 2008, a period of 58 months.

Falling interest rates - Green section "B" - this occurred between April 1998 and August 1999, a period of 17 months.  A similar falling interest rate period was from August 2008 to July 2009, a period of 12 months. 

Volatile interest rates - Orange section "C" - this occurred between September 1999 and December 2001, a period of 28 months.  A similar period of volatile interest rates was from February 2002 to September 2003, a period of 20 months. 

So taking these three defined parallel periods of activity it is very interesting to see what happened to property sales volumes and prices during these times.

 

Rising interest rates

The two periods of rising interest rates were lengthy and progressive and both covered periods when economic activity was strong and with it the threat of inflation and that was the trigger for tighter monetary policy.

The impact of these rising interest rates spread over 3 to 5 years was to depress sales as the chart below shows. It is somewhat striking to see the degree of correlations between these two discrete periods. The period in the 90's did see some recovery towards the end of the period but the first 12 months was generally depressed. In the case of the 2000's the long term impact (heavily influenced by the GFC) was a significant depressing of sales volumes.

When it comes to property prices as measured by the median price the trend across these two discrete periods again shows a high degree of correlation. Both periods witnessed a decline in the growth of property prices. It was only towards the end of the 5 year period in the last decade that prices actually went into negative growth.

Falling interest rates

The two periods in which interest rates fell were short-lived, representing just 17 months in the end of the 90's and just 12 months in 2008/9. Both of these periods came about as a function of the necessary reaction of the Reserve Bank to external stimuli - in the late 90's it was the Asian Economic Crisis and a decade later the Global Financial Crisis.

The impact of these significant cuts in interest rates was to stimulate property sales as the chart below shows with again a striking correlation between the two discrete periods.

When it comes to property prices the fact is the data shows that the falling interest rates aided the stimulation in property prices. In the most recent period of 2008/9 dragging prices back from actually falling, whilst in the 1998 period it managed to stave off what could have been and was very close to falling prices.

 

Volatile interest rates

The past 20 years have witnessed two coinciding periods when interest rates showed significant volatility, in the space of 2 years interest rates rose and then fell to return to the prior period rates.

These instances occurred during the early years of the last decade and were triggered largely by global economic events. Clearly this degree of rising and falling rates can lead to uncertainty.

In the case of property sales, volatility in interest rates seems to establish no clear correlation between the two periods nor in fact any clear direction of the market. The earlier 1998/9 period saw sales fall and then recover, almost in line with the interest rate hike and then cut; as for 2002/3 sales fell but with some rebound.

As to property prices during this volatile period, again as with sales volumes the correlation between the two periods is not clear and the trend seems to show no significant movement up or down. The 2002/3 period did see a very marked rise after 12 months as interest rates fell; this was though the beginning of a very strong bull run on prices through to 2007.

So whilst by no means scientific, there is clear data to support the view that the occasions when interest rates are rising is a time when property sales ease and prices slow; whilst interest rate cuts stimulate property sales and inflate prices. However uncertainty in interest rates tends to leave the market marking time. With the Reserve Bank clearly signalling that we are about to experience a period of 2 to 3 years of interest rate rises it would seem to be fair to say we will see sales volumes ease and price growth slow.