Myth 3: Low Interest Rates cause house values to rise.
That low interest rates have been the driving force behind real estate’s unprecedented rise is not a point of debate among economists. Quite simply, lower rates mean buyers can afford higher home prices.http://money.cnn.com/2004/07/13/real_estate/buying_selling/risingrates/
Low interest rates explain most of the rising house price storyhttp://about.commbank.com.au/group_display/0,1922,CH2071%255FTS6400,00.html
Interest rates and population growth are the keys to continued house price growth in Queensland over the coming year.http://www.loan.echoice.com.au/pages/h_housing_brisbane.html
One would be forgiven for reading these quotes and deducing that house values increase as interest rates fall, and I believe a myth has formed along the lines that ‘house prices rises have been reasonable given the low interest rate environment.’
It’s time to RIP APART ANOTHER MYTH!
Now apart from the following rather questionable investigation from Residex:
there is no statistical evidence for any significant relationship between interest rates and house price inflation.http://www.residex.com.au/index.php?content=article6
http://www.residex.com.au/index.php?content=article7
I will rely on my own logic to test this myth.
Low interest rates cause House Price Inflation by virtue of cheap credit, but they don’t alter the fundamental value of a house. What would a house be worth if interest rates were zero?
The value of the house value could be roughly calculated as:The cost of the land
plus
the building cost of a new house
minus
the age of the house divided by the expected lifespan of the houseRight? So what happens to that equation when interest rates rise? Nothing! What happens when interest rates fall? Again nothing! The only reason falling interest rates change house prices (as opposed to house values) is that more people find it easier to service more debt thus enabling & encouraging speculative bubbles to form.
Cheers,
F.[cap]And before anybody jumps down my throat over the meanings of the words price & value in eco-speak, I am simply trying to draw a distinction between fair value and CMV.
Foundation,
No I am not going to “jump down (your) throat” so relax; but I would like to ask you here:
How do YOU (or anyone for that matter) really define “fair value”??? [blink]
Are you trying to “myth bust” or play a game of semantics??
Cheers,
Jo
Originally posted by Monopoly:How do YOU (or anyone for that matter) really define “fair value”??? [blink]
You’re right, it’s not “fair value” either… but I don’t know how else to describe it! Rational Value perhaps?
Cheers, F.[cap]So what you are saying is there is no causal relationship between interest rates and changes in house prices. Intuitively, a reduction in interest rates, all other things being equal, would cause prices to rise. That is Economics 101
You set the bar higher with your first two myth busters Foundation, unfortunately this seems to be more semantics as Monopoly says.
I am sure there have been some statistical studies on house price movements and the factors that influnce them. Maybe that is the next challenge?
Foundation,
You have presented some excellent sources of information/data, all of which has merit, however and please don’t take this the wrong way as I am just expressing my curiousity out aloud, but EXACTLY WHY it is so important to you to discredit the doubling (every 7-10 year) of property prices theory???
I am not concerned one way or another, and I am not challenging your beliefs, I guess as a psych I am more intrigued by your entralment of this topic. Is it in the interest of generating feedback for the purpose of debate, or is it to confirm/deny any doubts you yourself have???
Personally, you can start up “myth buster #233” and IMO still be no closer to a resolution one way or another. And really, at the end of the day, does it really matter??? [blush2]
Cheers,
Jo
No – i like this one!! but we must be careful in differentiating between value and price.
interest rates will effect the price but not necessarily the value. so there is a correltation between price and interest rates. but not necessarily value. the availability of cheap money can cause distortions to the market that have nothing to do with value. value can be defined using many methods including yield, past performance etc.
Hi Woodsman, I was about to state that I think there is a causal relationship between house prices and interest rates, but I have reconsidered!
Interest rates are directly influenced by inflation. When inflation falls, the RBA ‘lowers interest rates’.
Falling interest rates have an inverse effect on investor psychology & sentiment and the wealth effect. Investors (and consumers in general) feel wealthier, are prepared to take on more debt, and become less risk averse (they can buy their way out of trouble). At the same time the economy appears to grow as debt funded spending lifts employment, production and, well, house prices!
This becomes a self-supporting cycle, as evidenced by the astonishing Australian debt statistics (check superman’s post regarding inflation vs house prices for links).
In a bubble situation (ie where ‘Market Price’ outstrips ‘Rational Price’) the underlying broad measures of inflation and particularly wage inflation do not keep pace with this change.
I guess to fully answer your question, I believe that interest rates are the ‘Flap of a Butterfly’s Wings in Brazil (that) set off a Tornado in Texas’ (property market bubble) but they don’t alter the ‘rational price’ one bit!
Cheers,F.[cap]Value in this context is now subjective…Hiw are we going to measure value as opposed to prices.
Five people can bid on one property or even an allotment of shares and based on what they perceive that asset to be valued to them make bids accordingly. Ultimately, an efficientmarket provides a price and by definition a valuation….
Of course, you could use a proxy for increases in value which might be a long run avergae increase based on historical performance…..But that gets us back to Myth#1…..
Interest rates are directly influenced by inflation. When inflation falls, the RBA ‘lowers interest rates’.I’d suggest inflationary expectations….as evidenced by Ian McFarlane’s comments today. Increase in rates will come in line with RBA’s expectation that inflation will increase..
In testimony to the parliament’s economics committee , Mr Macfarlane said while growth was slowing to annual rates below 3 per cent, the bank was concerned that bottlenecks could threaten the bank’s 2-3 per cent inflation target.
“It is up to the board to decide on the timing. But the public are aware that at this stage of the cycle it’s more likely that interest rates will go up than they will go the other way,” the governor said
AFR RBA flags rate rise despite slowdown 18/2/2005Have you not heard of Price Elasticity of Demand (economics 101 again) Price is directly influenced by demand.
Lower interest rates will of course make it more affordable to buy a house, hence increased demand.
Your views on value, whether it be fair or rational only become relevant regarding supply. If supply can match the demand then prices should remain the same ie land value and building cost.
Unfortunately with property there are too many other variables such as location, ocean views, beachfront, city centre etc etc – that’s where the supply starts to run out.
Curious to know what your investment fundamentals are?
Jeff
Hi Ibuy,
Originally posted by Ibuycashflow:Have you not heard of Price Elasticity of Demand (economics 101 again) Price is directly influenced by demand.
Yes, this I understand and agree with.
Lower interest rates will of course make it more affordable to buy a house, hence increased demand.So a relatively small number of people who previously couldn’t afford to buy a house can now afford to buy a house as housing affordability rises. Once these people have bought, the additional demand will abate unless interest rates continue to fall.
Your views on value, whether it be fair or rational only become relevant regarding supply. If supply can match the demand then prices should remain the same ie land value and building cost.I concur.
Curious to know what your investment fundamentals are?I think the important thing is to maximise returns! More later. Next episode of Myth Busters on Monday, and I’ll wrap this series on Wednesday, I think it will be pretty clear what the house price fundamental is by then.
Cheers, F.[cap]So a relatively small number of people who previously couldn’t afford to buy a house can now afford to buy a house as housing affordability rises. Once these people have bought, the additional demand will abate unless interest rates continue to fall.I don’t know where you get your data on, “the relatively small number of people”, I would be more inclined to refer to the number of house sales in a given area and compare that with price rises or falls in that area – a bit like viewing the sales and price history of a particular share rather than that of the index.
Just remember, once the “relatively small number of people” have bought, the price history is recorded. So even if demand does abate the new bar has been set – this does not mean prices automatically come down, they tend to come down if people are forced to sell. More than likely there will be fewer sales and/or a longer time to sell.
Cheers
Jeff
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