Over the past year, median advertised rents on realestate.com.au have increased by around 10% across most parts of the country.
With rents rising so quickly, concerns have been expressed that the Reserve Bank is exacerbating the rent crisis by raising interest rates by 3.5% in less than a year.
Landlords are facing significantly higher mortgage costs, forcing them to raise rents.
RBA Governor Philip Lowe is hesitant to accept the criticism. In his remarks before the recent Standing Committee on Economic Affairs, he wanted to say:
“The big problem here is the shortage of rental housing, which is causing higher rents, not higher interest rates.”
He has good reason to say so.
A simple version of economic theory does not support a link from interest rates to rents. More importantly, neither is the data.
There is no systematic relationship between interest rates and changes in rents at the national level. Also, there is no relationship at the individual rental property level when comparing rent increases with and without a mortgage.
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The rapid rise in rents has been attributed to soaring interest rates. is that fair?Photo: Getty
Instead, the reason rents are rising rapidly is because the rental market is extremely tight. There just aren’t enough rental properties for everyone who wants to rent.
In theory, higher interest rates should lower house prices – rents won’t go up.
In theory, rising interest rates will not affect the current supply of rental housing, nor the number of people looking to rent.
Interest rates do not (in theory) directly affect rent. Instead, interest rates are affected. housing prices – This is what we are currently seeing. House prices fell as interest rates rose.
Interest rates are important for rent, but only in the long run. Higher interest rates could reduce the number of homes being built, reducing the supply of housing. However, this effect takes time – about four years. [1]
For clarity, these are intentionally simple frameworks, intentionally abstracting away many important real-world details in order to focus on core concepts and mechanisms. [2]
Maybe those simplifications are important. Perhaps, in reality, rising interest rates are driving rents through another mechanism that these models do not capture.
Let’s look at the data instead.
At the national level, there is no relationship between higher cash rates and higher rents
The easiest way to find out if interest rates will raise rents is: If the RBA raises interest rates on average, what will happen to average rents across the country?
The upper panel of the chart below shows just that. [3]
Answer: Not often.
There is no consistent, systematic relationship between rising interest rates and rising rents.
There are various reasons why this approach is so flawed, which I will explain in the footnotes. [4] The bottom two panels show two better alternatives, showing what happens to rents after the RBA raises rates “better than expected”.
These alternative approaches do not change the situation.There is no evidence of a systematic response of rent growth to cash rate increases.
Looking at individual rents, there’s also no evidence that higher mortgage costs lead to higher rents.
Macroeconomic evidence does not support the hypothesis of higher mortgage rates and higher rents. However, in my view, the macro evidence is far from conclusive. There is so much going on in the economy at any given time that it is difficult to pinpoint just one such mechanism.
Now let’s look at this issue at the level of individual rental properties.
If landlords with loans pass on rent increases to their tenants, we can see that if the cash rate increases, properties with mortgages will see higher rent increases than properties without mortgages.
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Unfortunately, we do not know if a particular rental property has a mortgage. but we do You can find out how many years ago the rental property was last purchased. We also use “time since last purchase” as a proxy for “mortgaged”, assuming on average that more recent purchases are more likely to be mortgaged or have more outstanding balances. can.
If the higher the mortgage interest rate, the higher the rent, the “premium” for newly purchased properties vs. old properties (i.e. properties with and without a mortgage) is: change systematically with interest rates. [5]
The answer is there is no evidence that rents on mortgaged properties will be higher than rents on unencumbered properties when interest rates rise. [6]
Rents on recently purchased properties (that is, rents on recently purchased properties) remained static at 6% from 2007 to 2008, despite rapidly rising interest rates. Even when interest rates were cut sharply in late 2008 and early 2009, premiums did not fall.
Premiums were again flat during the rate hikes in late 2009 and 2010.
And during the pandemic, when rates were cut, premiums gain,and decreased This is despite the recent rapid rise in mortgage rates in 2022-2023. [7]
All of this runs counter to what you would expect if rents on mortgage-heavy properties rose when interest rates rose. [8]
The only counter-example is the very slow decline in premiums on recently purchased properties from 2010 to 2015 and the decline in mortgage rates from 2011 to 2016. But this is a slow adjustment and probably a structural change rather than a cyclical one.
So why are rents going up?
If theory, macro evidence, and micro evidence all refute the idea that mortgage rates systematically raise rents, why are rents rising so quickly now? ?
Simply put, you don’t have enough rentals.
The rental vacancy rate, which measures the number of rentals currently available as a share of the total number of rental housing in Australia, stands at just 1.5% nationally. That’s about half what it was before the pandemic. This means that rental properties are hard to find and the competition is fierce when they come out.
With the rental market so tight, rents will rise Whatever happened to interest rates.
There is no doubt that some landlords are using higher mortgage rates to justify their rent increases. But it’s a justification. If the rental market wasn’t so tight, landlords wouldn’t be able to pass on those costs.
Asking the RBA to solve the rental crisis by cutting interest rates is not the right solution.
The solution to the rental crisis is not to lower interest rates, but to rent more. This means encouraging new investors and building more homes in the long run.
[1] In the short run, this model actually lowers rents as interest rates rise. This is because higher interest rates slow the economy (which means more unemployment). This reduces their willingness or ability to pay rent. See below for examples of these models in the Australian context. Sanders and Tulip (2019) and Ballantine et al. (2019).
[2] For example, arbitrage costs are ignored (these are large and probably significant). Landlords are supposed to be price takers (which is clearly not true – landlords have some monopoly power). and so on. These frictions, plausibly, could create a causal relationship between rising interest rates and rents.
[3] The graph shows the impact of a 1 percentage point increase in cash rate. Jordan (2005).
[4] The main concern is that interest rates will fluctuate in anticipation of economic development, which may affect rents, or similarly that both interest rates and rents may be influenced by other variables (e.g. unemployment rate, which can be taken into account). not). The former of these are often referred to as price puzzles (e.g. Romer and Romer (2004)or the Australian version Bishop and Tulip (2017)). The shock series I will use later does not fully address this concern as it is conditioned on forecasts of inflation, GDP and unemployment. no rent.
[5] I estimate this “premium” with a simple hedonic regression framework. This framework identifies advertised rentals based on key characteristics of the rental property (property type and bedrooms, location) and how long ago the property was last purchased (compared to when it was purchased). return the fee. We are looking for rentals. )[5] Run this regression every quarter since 2007 to get an estimate of the premium for recently purchased rental properties over time.[5]
[6] More precisely, the correlation between changes in mortgage rates and changes in recently purchased issue premiums is actually slightly negative, but very close to zero and statistically very close to zero. There is no difference.
[7] Much of the increase in premiums during the pandemic was due to higher premiums on recently purchased rentals (i.e. less than a year old). Excluding this group and comparing premiums for his 1-3 year old purchases versus purchases less than 2 years old, the broad results are robust. This rent premium for this group also shows no relation to mortgage interest rates.
[8] The only argument in favor of “mortgage rates pushing rents up” is that both the premium on recent purchases and mortgage rates have declined over the roughly five-year period from 2011 to 2016. rate. So my interpretation is that this is an accidental change and not causal.