What are rising interest rates doing to Melbourne off-the-plan real estate sales

The jury is still out on the impact of the long-term health of Melbourne's property market, however it’s safe to say with increased interest rates and a long term increase rising lending standards we are starting to see some impact on the localised sector.

The combination is causing developers to worry about their ability to secure financing for new developments, which could see construction stagnate.

Falling house prices have been shown to have an inverse relationship with the rate of new dwellings being built.

Falling house prices have been shown to have an inverse relationship with the rate of new dwellings being built. This is because when it becomes a buyer’s market, people are less likely to sell their homes and more likely to build new ones.

In other words, falling house prices lead to construction activity being driven by a rise in demand for housing (more people want to buy), rather than a reduction in supply (more people selling).

Developers in Victoria are already expressing concerns as lending standards are tightened across the country.

Property developers are bracing for a prospective of a downturn for the Victorian real estate market.

Developers in Victoria are already expressing concerns as lending standards are tightened across the country. Loan-to-value ratios, or LVRs, have been rising and many buyers have been forced to use their own money as a deposit.

The tightening of lending standards has been a slow but steady process over the past year with most major banks increasing their LVRs by 0.5 per cent in October 2018 and again by another 0.5 per cent in April 2019.

Whilst Developers' cash flow problems have been exacerbated by the lack of financing options, with bank funding for off-the-plan apartments drying up as APRA clamps down on lending and banks become increasingly cautious about their exposure to this type of product.

We know this has encouraged private lending to become more mainstream within the off-the-plan sector for larger developers, however this is likely to cause some issues for developers who rely on off-the-plan sales to reach financial milestones with lenders.

The increased cost of finance is still a cultural shock for purchasers, who have enjoyed a decade of cheap capital, however we still see investors and particularly first home purchasers who are still sitting on the sidelines waiting for a rebound in prices, much like we saw in early 2020. Considering the scepticism from the RBA's decision making regarding interest rates, we could be seeing perfect storm conditions that could dramatically impact upon the sector in the short term. The RBA's decision to lift rates multiple times in 2022 after stating they wouldn’t in 2021 will continue have a significant impact on property prices, as borrowers struggle with higher repayments and lenders become more cautious about who they lend money to.

The fall in property values has seen developers seeking larger loans and higher loan-to-value ratios for property buyers.

To help you understand the impact of rising interest rates on property sales, let's look at loan-to-value ratios.

Loan-to-value ratios are a measure of how much of a loan is borrowed compared to the value of the property being purchased. For example, if you borrow $250,000 and your home is worth $300,000 then your loan-to-value ratio is 80%. This means that for every $100 in equity in your home, there's only $20 equity remaining - so if there were a decline in property values over time (like we're seeing right now) then you would have less money available to repay that debt because it was based on an inflated price.

On the other hand, if someone had borrowed $650k but bought their house for only $650k then they would have 100% equity meaning even though their house depreciated by 10%, they wouldn't need to repay anything. So higher LVRs mean more money for investors or developers and less risk for buyers who can just walk away from their investment when times get tough.

We are entering uncharted territory for interest rates if the consumer price index continues to rise at this rate.

As the Reserve Bank of Australia (RBA) continues to raise interest rates and banks continue to tighten their lending criteria, off-the-plan sales are already starting to slow down.

It remains to be seen what the long-term impacts will be on real estate market in Victoria, but it is clear that property developers are already feeling its pinch. With predictions that interest rates will continue to rise this year and listing number and property prices continuing to fall across the country due to stricter lending policies, it could take some time before we see an increase in mortgage rates again.