RBA research has shown high-income suburbs are the most sensitive to interest rate changes. RBA research has shown high-income suburbs are the most sensitive to interest rate changes.
Finance Property Prestige housing markets are the most sensitive to interest rate changes: RBA Updated:

Prestige housing markets are the most sensitive to interest rate changes: RBA

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New research has shown house prices in high-income suburbs are the most sensitive to changes in interest rates – supporting earlier claims the top end of town is leading the housing boom.

Falling interest rates boost demand for housing as they make future rental payments more valuable to investors and allow buyers to borrow more money and bid up prices.

This demand is often met by a lift in supply.

But in high-income areas, where the supply of new housing is often restricted, it is mostly met by higher house prices.

Reserve Bank researchers Calvin He and Gianni La Cava found for every 1 percentage point increase in income, house prices fall an extra 0.032 percentage points in the two years after a 1 percentage point rise in interest rates.

That may not sound like much, but given the large difference in incomes and values across locations, it can add up to millions of dollars.

This means values at the top end of town will climb much higher after the Reserve Bank cuts rates and fall much further when it raises them.

The findings are part of a research paper exploring how the impact of interest rates on house prices varies across different locations.

Mortgage debt and investor activity also important

The research paper found areas with higher levels of mortgage debt and a greater number of investors are also very sensitive to interest rate changes.

When it comes to the number of property investors living in a suburb, the researchers found that an area with 10 percentage points more investors would see prices fall a half percentage point more, in the two years after a 1 percentage point increase in interest rates.

“This may indicate that, relative to the broader population, housing investors have different expectations of capital gains on housing,” the researchers said.

“Alternatively, due to personal preferences, housing investors may have discount rates that are more closely tied to short-term interest rates.”

Because interest rate movements affect expensive suburbs more than affordable suburbs, the researchers said that rate cuts worsen housing inequality, too. But only temporarily.

“The differences [in response to monetary policy] across all price deciles becomes statistically insignificant beyond two years,” the researchers said, adding that the biggest gap in the rate of price change (1.4 percentage points) comes six quarters after an interest rate move.

“This implies, for example, that housing prices would fall by about 3.7 per cent in the top four price deciles if prices in the median area fall by 2.3 per cent in response to a 100 basis point increase in the cash rate.”

The research comes just days after Reserve Bank Governor Philip Lowe told a forum in Melbourne “structurally high levels of debt relative to our income” made Australia vulnerable to economic shocks.

Dr Lowe noted that last year’s rate cuts had somewhat lessened this vulnerability by helping people pay off the principal on their home loan.

But he said we had probably now reached a point where “the lower level of interest rates are encouraging people to borrow yet even more” – consequently turbocharging the housing market.

The central bank paper supports earlier research from CoreLogic that claimed buyers in Australia’s prestige suburbs were leading the market recovery.

Driven by interest rate cuts and looser bank lending, national prices have rebounded 6.7 per cent since finding their bottom in July.

Tim Lawless, head of research at CoreLogic, told The New Daily more expensive suburbs had seen the greatest benefit of cheaper money for a few reasons.

Firstly, values in these suburbs had fallen most during the downturn, meaning buyers rushed to snap up homes in these areas as soon as the market stabilised in July.

Secondly, the Australian Prudential Regulation Authority’s easing of serviceability requirements boosted the borrowing capacity of higher-income earners more than lower-income earners’, allowing them to bid up prices in prestige markets.

Thirdly, supply is more restricted in expensive suburbs as they normally have less land available and stronger community opposition to new development, known as not-in-my-backyard (NIMBY) sentiment.

Mr Lawless added, however, that the prestige suburbs aren’t the main drivers of price growth in all cities.

“Hobart is a good example,” he said.

“It’s actually the more affordable end of the market that’s showing the strongest performance now – and potentially that’s because we didn’t see much of a correction across Hobart. “