The returns from investing in Australian residential property are primarily derived through capital growth, not yield. The capital growth is driven by Australia’s high population growth rate and population concentration. Interest rates have a short- term impact on Australian residential property prices but have had limited impact on long-term performance of the asset class.

As shown in the graph below, many residential property markets across the world exhibit higher yield and relatively lower capital growth than the Australian market. Consequently, property investors will have the opportunity to achieve medium-long-term returns through exposure to high capital growth assets within the housing market, rather than seeking to maximise yield as they might in other countries or property asset classes in Australia.

Over the medium-long-term, key drivers of this historical capital growth in the Australian residential property market have been population growth and concentration.

It’s worth noting that:

• Australia has consistently had amongst the highest population growth rates in the Western world as shown in the graph below; and
• Australia’s population is extremely concentrated in a few large cities and those concentrations of population are continuing to increase. Over 50% of Australia’s population is concentrated in just three large population centres whereas in the UK it takes 9 cities to reach this proportion and in the United States it takes 37.These factors account for much of the historical long-term capital growth in urban property values in Australia through their impact on the value of scarce, but well-located suburban land where supply is largely fixed. These factors will likely remain persistent and continue to drive long term capital growth in the asset class.

Some commentators have attributed recent record low real interest rates as the primary driver of historic growth in Australian house prices, suggesting that the RBA’s intention to return to higher cash rates over the long term signifies the end of Australia’s longstanding property price growth. However, many countries have experienced record low interest rates in recent years, yet few have seen the same house price growth.

The far from simple relationship between interest rates and house prices can be seen by observing the history of house price growth and interest rates in Australia over the last 60 years. Looked at another way, the graph below shows the interest rate changes during each doubling of house prices since 1960.

Observing this graph, it is clear that the correlation is not simple. House prices doubled four times between 1960 and 1988 as interest rates rose and continued to double as interest rates fell or were flat between 1988 and 2021. This suggests that long-term house price growth is occurring largely independently of interest rate movements over the long term and that the two factors are not perfectly correlated.

There are several factors that mitigate against a simple relationship between interest rates and house prices. These include:

• the residential asset class is only 23% geared and indeed a large proportion of properties are owned outright and so have no interest to service at all; and
• while rises in interest rates may affect some buyers and owners, they would need to affect sellers’ needs/ desire to sell before a transaction occurs at a lower price. In many cases, financially secure owners simply refuse to sell in lower price climates (seen in lower transaction volumes in the market as was the case in early 2023) and buyers simply revise their expectations and purchase a cheaper property with their lower budget.The clearest indication of population driving land values as a key driver over the long term can be seen from the differentials between the growth rates of houses versus high density apartments (see figure 5 below) . If interest rates were the dominant driver, the expected impact might be similar across housing types. In the short term it can be, however over time the land component drives much stronger growth in values of detached dwellings in every interest rate climate.