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It’s widely known that property markets are extremely sensitive to interest rates. It is less well known, however, that it is the real interest rate that investors should examine in relation to property prices.
Faced with the danger of rising real interest rates in the near future, investors may want to revisit what the real interest rate has meant historically to the Hong Kong property market.
What is the real interest rate?
Quite simply, the real interest rate is the nominal interest rate net of inflation. It makes sense that we should consider the real interest rate when looking at property values because it measures the true cost of borrowing, net of the increase in prices. For example, if the nominal interest rate is high, but the inflation rate is even higher, then the real interest rate will be relatively lower. In other words, the cost of borrowing will be less than investors might think.
The effect of the real interest rate on Hong Kong property market over time
Since the real interest rate reflects the cost of mortgages and most residential property purchases are financed with mortgage loans, the ups and downs of real interest rates are historically useful indicators of residential property price trends in Hong Kong. Consider the following table:
|Year||Change in Residential Property Price Level||Nominal Interest Rate||Inflation Rate||Real Interest Rate|
Sources: Rating and Valuation Department, Census and Statistics Department, Hong Kong Monetary Authority
Nominal interest rates were relatively high from 1992 to 2000. Yet, real interest rates were low from 1992 to 1997, resulting in negative values due to even higher inflation rate during the same period. Not surprisingly, property prices soared in general from 1992 to 1997, with the exception of the year 1995. In that year property prices declined mainly because the Hong Kong Government introduced various measures in 1994 to increase land supply and stabilize the property market. Overall, property prices in Hong Kong were generally bullish from 1992 to 1997 due to negative real interest rates.
From 1998 to 2000, nominal interest rates remained high. On the other hand, the inflation rate declined sharply in 1998 and even turned negative from 1999 onwards. Coupled with decreasing nominal rates from 2001 onwards, the real interest rate was notably high from 1998 to 2003. As you might imagine, property prices went south during the high real interest rate environment from 1998 to 2003.
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