interest rates and property prices - negative correlation?

[guitarplayer]

I often read that now is a good time to get a mortgage since interest rates are real negative. I wonder, is it not priced into the equation already?

If mortgages were harder to afford, there would be less demand for real estate ergo prices would go down. In effect, I would pay more interest on a smaller mortgage so things would even out.

I would appreciate comments from people who were observing the behaviour of the real estate market wrt the above.

[2Birds1Stone]

Cheap money does tend to inflate RE prices. Right now we are seeing a boom in RE all over the world as people flee dense cities and/or anticipate inflation from the tremendous increase in money supply.

[UK-with-kids]

Prices tend to reflect the balance between supply and demand.

Assuming the world doesn't completely change and people decide they don't want to live in cities any more, on the supply side the availability of property will always be limited in cities due to basic geometry - just draw concentric circles on a map and notice the difference in area between each band. Even more so when the city is limited on one or more sides by features like water or mountains. As you get further out there is 'substitutability' - no particular reason for one town or another to be more expensive as you can always go elsewhere. Hence there's a ceiling on anywhere without a special factor supporting its desirability.

That gets us to demand, which is not just the number of people trying to buy property, but the availability of finance (confusingly this is the 'money supply' but is definitely a demand side factor). How much finance people can raise and service is called 'affordability'. So to answer your original question, it's definitely priced in because the main driver for the boom in prices has been that people can borrow more and more money because they pay less and less interest. So if interest rates had to rise, e.g. to defend a currency or because inflation was getting out of control, property prices would definitely fall due to nobody being able to get a mortgage for such a high value any more.

When I bought my first property 15 years ago I paid 6% interest. Admittedly that was a premium rate as I didn't have a large deposit, so it should probably have been more like 4%-5%, but seeing as I can now borrow money at say 2%-2.5% it's no surprise if the house has doubled in value, or should I say doubled in price.

[guitarplayer]

Thanks @2B1S for confirming my thoughts. Yes it does seem to me reasonable to think that there is more cash that people want to do something with, because they don't want to buy shares. This though applies to people with savings, I think there are quite a few people who will lose jobs and not being able to afford mortgage will have to sell. But this is a topic for another thread.

@UK-with-kids this is a very useful answer and particularly because UK based and I am based in the UK as well, thank you! Yup I definitely see where you are coming from re money supply being a demand side factor, this is precisely what I was writing about when mentioning mortgages hard to afford. I am trying to work out the optimal strategy for using LISA* funds for a deposit. It seems to me, and in line with your reasoning, that the best approach would be to accumulate cash on the LISA harvesting 25% top up from the gov and wait for property prices to go down. This would likely be accompanied by higher interest rates on mortgages. However, having a lot of money on LISA, I could afford a very small mortgage (say £20k-£30k) where interest rate would not really matter all together.

*this was not around 15 years ago so maybe you are not familiar with it: it is a sort of ISA where you can deposit up to £4000 a year and this is topped up by £1000 by the gov. Can be withdrawn after turning 60 or for a deposit for the first property. Applies to both people in a couple, i.e. DW and I can each year put in £8k and instantly get £10k.

[Dream of Freedom]

It's easy to see lower interest rates allowing a larger purchase. The thing is that academics link home prices to inflation and when inflation is high interest rates are normally high. When inflation is low interest rates are kept low. So if there is an affect it is probably not that big.

[UK-with-kids]

I was lucky that despite buying after some ridiculous house price inflation, and with a very low deposit, I didn't get caught in a negative equity situation. And although I sometimes had gaps in employment, interest rates fell so my mortgage got cheaper and I was never in trouble. There are plenty of other places in the UK and elsewhere where prices collapsed in 2008/9 and still haven't recovered.

Another stupid time to buy would have been 1989 when "MIRAS" was abolished - that was interest rate deductibility which they still have in the US, but we don't have in the UK any more. There's a UK blog called simplelivinginsomerset which talks a lot about the long term consequences of buying at the wrong time (he bought a house in 1989). It's kind of a massive problem if you buy at the end of one paradigm and then everything changes in a bad way.

Is now a stupid time to buy? It's really hard to say. The government are propping house prices up by abolishing stamp duty until next March. Interest rates are still low and the pound is holding up ok for now and inflation hasn't taken off. But it's hard to imagine that there will be so much competition for housing if immigration falls, not just due to Brexit but also due to the lack of jobs in general, especially now the world has figured out jobs can mostly be done remotely. Except for all those restaurant and coffee shop workers, but then all the city centre places are shutting down anyway of course. Meanwhile, the government are going all out with relaxing the planning system to encourage hundreds of thousands of new homes to get built.

In other words, in a year or two there could be a lot more supply and not so much demand.

[UK-with-kids]

Another thing that doesn't get fully considered is that price inflation isn't the same thing as wage inflation. If price inflation goes up, e.g. due to the weakening pound, increases in oil or food prices or whatever, then as a UK resident you are poorer. You can go see your boss and ask for a pay rise to compensate, but we don't have Unions much any more and there are plenty of other people who would do your job for the same money or less. Like Eastern Europeans who are happy to live 10 people to a 3 bed house for example (I am not making this up). The result is that house prices don't necessarily increase even if we get inflation because of "affordability". If people can't get a larger mortgage because their income isn't any higher then there won't be the same competition for houses that pushes prices up.