Real estate markets are driven by a number of factors. House prices reflect the sensitivity of those factors. The Inflation Rate is one of those factors which is has a direct relation to interest rates.
Inflation and RBA cash rate – Australia 1970 to 2017
The above graph shows the historical relationship between the RBA cash rate and inflation. There is a very high correlation between these two, with metrics tracking in similar directions and currently at historic low levels. Moving forward, house price growth is expected to track in line with these figures.
Interest rates are adjusted by the Reserve Bank of Australia in order to meet its inflation targets of two to three percent. When the RBA lowers interest rates consumer spending increases, stimulating the economy; the price of borrowing money goes down, buying homes becomes affordable, so property prices increase, spurring inflation. If the RBA wants to slow down the economy by reducing spending the opposite happens - it increases interest rates. Higher interest rates make servicing loans costlier, so people borrow less money, spending is reduced and house prices go down. These are the supply and demand dynamics of an economy.
Property prices tend to move in line with inflation and for that reason property is a great hedge against inflation. Inflation impacts against savings, while interest rates impact against borrowing. For instance, an $800k loan on a 30-year period at a fixed rate of 6% will cost approx. $1000 a week. If inflation rises, the value of money is eroded as the purchasing power of $1000 decreases. However if an investment were made in property, the price of the property would go up, hedging against inflation. In addition, a real estate investor also has the capacity to receive rental income from property which can also can increase in line with in inflation.
Therefore, choosing a property that grows in value at a faster rate than the cost of holding it is essential to generate maximum return on invested capital. In other words, the key for investors to make money in real estate is to choose an asset that grows at a greater rate than the rate of inflation.