Knowing the Cycle: Interest Rates and Income

Posted by Luke Graham

In August we discussed the relationship between rental vacancy rates and the Reserve Bank ‘cash rate’, which has a strong influence on interest rates paid on mortgages.

Rental income, more commonly referred to as rental yield, also has a relationship with the cash rate. As it happens, the relationship is similar to the one found with vacancy rates, which is of no particular surprise.

For this analysis, we have used a Blue Wealth developed index for the changes in median rent of one bedroom apartments in metropolitan Melbourne since 1999. The fluctuations in this index figure are then compared against changes in the cash rate.

In June 1999, the cash rate was 4.75 per cent and the median rent for a one bedroom Melburnian apartment was $130 per week.

In March 2014 the cash rate stood at 2.5 per cent, which is the lowest over the fifteen year sampling period. The median rent of a Melburnian one bedroom apartment in March 2014 was $305 per week, just shy of the $315 peak in December 2013.

So it is apparent that when the cash rate increases rentals are strengthened, and when the cash rate goes down rentals are comparatively weaker. But how has this actually operated over the past fifteen years?

1999 – 2006

This period bridged the new millennium and the prelude to the Global Financial Crisis (GFC). The cash rate peaked in late 2000 at 6.25 per cent, which was followed by double-digit annual rental growth. Once the cash rate ‘normalised’ around 4-5 per cent, rental growth slowed significantly, in cases at a third of the rate of the late 2000 peak.

2006 onward

As economic activity sped up leading toward what became the GFC, the cash rate reactively increased in a similar way to 1999-2000 except this time the peak was 7.25 per cent which was reached in mid-2008. The period leading up to this peak again saw significant increases in rental growth of double digits. When the cash rate dramatically declined as a result of the GFC rental growth also decreased, but negative growth was fortunately never encountered over a period longer than twelve months.

One interesting change observable within this market is that, prior to the GFC, movement in the cash rate came before rental growth, whereas since the GFC the opposite seems to be the case. There could be a number of reasons for this. One is that the ’cause and effect’ relationship between the cash rate and rental income growth could have reversed due to shifts in the Australian economy that have occurred over the last five years.

Posted by Luke Graham, on 30th Sep 2014