Over the past 12 months, the rising cost of living has made it increasingly difficult for individuals and families to make ends meet. Expenses, including interest rate hikes of 4% (and potentially more to come), as well as rental increases, have taken their toll. However, there is a silver lining to this, even though it’s hard to see right now…
Amidst this challenging environment, property owners in Australia will be able to find solace in the phenomenon of inflation. While wages have only seen modest growth of around 2.5% per annum over the past 13 years, property prices have more than doubled in most states across the country.
One of the primary drivers behind the significant increase in property values in recent years has been the increase in demand and decrease in supply, coupled with a sharp reduction in interest rates which has increased affordability and borrowing capacity. As interest rates dropped to historic lows, borrowers found themselves with greater affordability and access to financing. This unleashed a wave of demand in the property market, leading to price escalation. However, with the cash rate dropping to 0.1%, there was limited room for further rate reductions, making the rate of property value increase unsustainable.
To understand the long-term benefits of inflation for property investors, let’s consider an example using Sydney’s property market from 1970 to 1990. During this period, inflation played a significant role in driving property prices upward, and the median house price in Sydney increased from $18,700 to $184,600, reflecting the compounding effect of inflation at nearly 9% per annum over the same period.
While the coming 12 months may present challenges, it is crucial for property owners to maintain a long-term perspective. History has shown us that property prices tend to rise over time, even with short-term fluctuations. The same principles that fuelled property value growth in the past can continue to drive appreciation in the future, and most importantly, at a sustainable level.
Applying the concept of inflation to today’s property market, let’s consider the median house price in Sydney, which currently stands at $1.052 million. With an average mortgage of $602,000 and a median household income in NSW of $91,000 AUD, the mortgage-to-income ratio is approximately 6.6. Assuming an average inflation rate of 3% per annum, over 20 years, the median household income would increase to around $157,000 AUD (assuming it keeps up with inflation), while the average mortgage balance would decrease to approximately $324,000 AUD. As a result, the mortgage-to-income ratio would improve to approximately 2.1. These projections suggest that inflation, coupled with mortgage repayments and increasing income, can lead to improved mortgage affordability for property investors over time.
So what do I think?
If you’re a property owner, hang in there, continue to remain diligent, and keep in mind that better times are ahead. If your loan is still fixed at the low or sub 2% mark, try budgeting for a rate of 6% and save any funds you have left over so you know what is to come.
If you’re thinking of buying, do all your usual due diligence, but keep in mind that the market is still strong. Whilst the “mortgage cliff” is coming (or is already here for some), there so far hasn’t been any indication that there will be a dramatic price drop like some are saying, such is the resilience of the modern-day Australian property owner, so you might be wasting your time if you’re waiting around for a bargain to pop up.
Historical trends have shown that property values tend to rise over time, even with short-term fluctuations. By leveraging inflation’s compounding effect, property buyers and owners alike can build equity and increase their net worth, so long as it is done in a safe and considered manner.