With Australian inflation running at 7.8% (December 2022), many investors are focused on investing in assets that are positioned to generate attractive returns if inflation remains high looking forward. Residential property is generally regarded as one of those assets. However, the outlook for residential property is complicated by rising interest rates which are often associated with lower property values.
The key point for investors to understand is how the conflicting market drivers of high inflation and rising interest rates impact rental growth and property demand, and supply the fundamental market drivers.
What happens to rent during periods of high inflation
If the market is relatively undersupplied as has been the case over the past two years, landlords will generally try to increase rents to offset higher property ownership costs such as interest, building, and maintenance costs. We saw this in 2022 with a 14.6% average rental increase for capital city houses. A 14.6% rental increase is significant even in the face of 7.8% inflation.
The fact that rental increases are outpacing inflation is important to understand since it provides compelling evidence of residential property’s inflation protection attractions. And of course, higher rents tend to lead to higher prices over the long term.
What about the potentially negative impact of higher interest rates on property values?
This is a particularly valid question since Australian property values have trended downwards in recent months as higher interest rates have dampened demand. However, bear in mind this correction (thus far) has been a short term correction within a broader uptrend.
Property values are still generally well in excess of pre-pandemic levels, while rentals are generally significantly higher. And when you consider there are only .30,000 dwellings available for rent at present while the net Australian population is expected to increase by c. 400,000 over the coming year, it seems likely that property prices will resume their upward trajectory despite higher interest rates.
So the impact of strong rental growth is likely more than to offset higher interest rates in the coming months.
As Landen’s Director, Jim Dionysatos explains:
‘We’re optimistic about residential property in a high inflation environment. Once the market completes the current correction, we believe residential property is positioned to generate strong returns regardless of higher interest rates. It’s a classic undersupply situation that invariably leads to higher property prices. As such, we’re advising our inflation-focused clients to get positioned for the next leg of the bull market.’