Properties & Pathways

How does inflation affect property prices?


07 June, 2022

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Savvy property investors have a lot to keep their eye on: interest rates, wages growth, unemployment, market rents, market movements and of course buyer and tenant demand. One price driver that has more impact on property prices than the first-time investor might consider is inflation. But how does inflation affect property prices?

We’ll get to that soon. But first, seeing as you’ve come here for a quick lesson on inflation, let’s tackle the subject’s definition.

What is inflation?


is the decline of a currency’s purchasing power over time. This decline is reflected in the increase of an average price level of a basket of selected goods and services in an economy over a specified period.

The rise – expressed as a percentage and called the inflation rate – basically means that a particular amount of currency buys less today than it did yesterday.

how inflation affects property prices

Put simply, inflation is the decline of a currency’s purchasing power over time.

In Australia, our inflation rate is represented by the Consumer Price Index (CPI). The Australian Bureau of Statistics (ABS) releases Australia’s CPI movements every quarter (its latest in March 2022 showed CPI rose 2.1 per cent in the first three months of 2022) using the CPI of thousands of items across a range of categories. The change in these items helps the ABS calculate the inflation rate.

Australia has a targeted inflation rate of 2 per cent to 3 per cent. Meaning inflation isn’t necessarily a bad thing – we want some inflation.

This is because inflation increases demand in the short term as consumers expect prices to continue rising. Stores sell more, factories produce more, and both require workers to do so. The whole process stimulates the economy.

How does inflation affect property prices?

property values inflation rate australia

Property prices in Australia are linked to inflation as a result of fluctuations in interest rates.

Inflation can impact any good which has a limited supply. But it’s inflation’s relationship with interest rates that creates price movements in the property market.

When interest rates are low, buying a home can be more affordable. This results in increased buyer demand. Providing there is some scarcity in the market, property prices will generally increase as a response to the uptick in demand. But taking it back a few steps, how does inflation influence interest rates?

Inflation’s relationship with interest rates

In Australia, inflation and the cash rate are strongly correlated. Interest rates can be used as a tool to increase or slow down inflation (e.g. increasing the cash rate to reduce buyer demand and thus reduce price increases), and that’s exactly what we’re seeing in today’s economy.

Since the pandemic, property prices in Australia have catapulted. Real estate accounts for 22.3 per cent of the total weight of Australia’s CPI, so it’s crucial to the RBA’s inflation targeting that property prices don’t spin out of control. The RBA have recently increased interest rates – for the first time since 2010 and then again as we published this today, to 0.85 per cent – as a measure to control “very high inflation numbers”. With inflation up 5.1 per cent over the 12 months to May 2022, we’re expecting to see several more rate increases in the near future.

Even US inflation impacts Australian property prices

us inflation australian property

US inflation has a big impact on borrowing costs in Australia.

Because Aussie banks and financial institutions borrow from US debt markets to finance many of their fixed rate mortgage products, borrowing costs in Australia are usually tied to US interest rates. (Banks borrow from a range of sources before lending money to their customers, but the US debt market is a crucial source.)

The recent increase in homeowners fixing their interest rates caused concern because of skyrocketing US inflation. Banks don’t need to – nor do they – wait for the Reserve Bank’s monthly cash rate announcement to adjust their rates. If lenders see that their costs of borrowing will increase in the future, then yours will likely follow.

The result of increased interest rates on property prices? Higher borrowing costs can take buyer demand off the boil. And as it’s demand that drives asset values, property prices can decline if inflation rises.

The real victims of high inflation

australian property values inflation rate

Investors might worry less about their property value when inflation rises and be more concerned about the value of their cash deposits in the bank. Because if interest earned from deposits don’t outperform the rate of inflation, investors are effectively losing money.

As we’ve seen, inflation reduces the purchasing power of a currency. So, in a high inflationary environment, the value of a dollar in the bank today will be reduced by the time you wake up tomorrow. It’s crucial then to find investments with solid returns, which offset the rate of inflation.

This is where real estate can pay real dividends for investors and homeowners. Because – as the property market’s history shows us – the return from property investments often outweighs inflation.

Real estate as a shield from inflation

Annual yields from commercial real estate investments

can be in the league of 5 per cent to 8 per cent (and sometimes higher). And that’s not even taking into account capital growth from careful planning and strategic investment initiatives (we’ve achieved a total investor return of up to 100 per cent for our investors).

Residential property yields are more modest at 2 per cent to 3 per cent per year. But it’s the capital growth that really attracts investors to the housing market.

Should property investors worry about future interest rate hikes? Well, most Australians are well ahead of their mortgage repayments and the Reserve Bank will have a keen eye on the impacts of interest rate fluctuations on home loan repayments. As for property prices, we’ve seen an incredible pace of growth in the last 18 months. While some markets, like Sydney and Melbourne, have come off the boil, markets in areas like Perth and Brisbane are likely far from seeing a dramatic price turn.

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