Rise in property market likely to continue
Continuing high rates of clearance at recent auctions and many sales at prices considerably above vendors' reserves indicate lower interest rates are contributing to a boom in property prices.
Whether or not this price surge will be dampened by our weakening economy remains to be seen. Nevertheless, based on the Canadian experience, there's a real risk of a property price bubble if our interest rates remain low or are even reduced further.
Canada's economy was in good shape when the global financial crisis hit and, unlike that of the US, its mortgage market was not damaged by the sub-prime crisis. But because of its proximity to the world's largest economy, Canada has been forced to reduce its interest rates to the very low US level for the past five years. The result has been a boom in Canadian house prices because, unlike in the US, Canadian residents still had access to mortgage funds but at much lower cost.
Low interest rates are a trap for unwary investors, encouraging them to take on larger loans than they might otherwise have considered. The biggest risk for borrowers is, of course, the possibility of future rate increases. Moreover, the longer interest rates remain at artificially low levels, the less attention borrowers pay to the prospect of future changes.
For Australian borrowers, low interest rates are a recent phenomenon and many borrowers should still be aware of the possibility of future increases. But recent auction activity, including in the higher-price segment of the market, suggests our buyers are prepared to increase their borrowings with the variable rates now between 5 and 6 per cent.
The lower rates are not the only factor contributing to the stronger market. Cuts in the concessional tax arrangements for superannuation and continuing unlimited tax assistance for negative gearing have increased the attractions for higher-income taxpayers to borrow large amounts for both property and share investments.
The ready availability of mortgages for investment properties makes this the more attractive and easiest gearing option adding to overall property demand. The share market is still well below its previous pre-financial crisis peak but residential property prices, especially in the major capitals, are already reaching or exceeding previous high levels.
Although the tax assistance to negative gearing has not so far been raised as an issue in the election period, as with the GST, the odds are that any changes will be put in the too-hard basket by both major parties. If this is a correct assessment, the outlook is for further increases in property prices as the yield from cash and and term deposits falls even below the after-expenses rental yield on residential property.