What will happen to the share market and residential property market in 10 years?

With the interest rate rising, what will happen to the share market and residential property market over the next 10 years?

How interest rates are determined

· Inflation ultimately drives interest rates.

Rising inflation = rising rates. Falling inflation = falling interest rates.

· Most financial indicators and economic commentators, domestically and internationally, point to a likely gradual rise in medium to long term inflation, and therefore likely the same with interest rates, over the coming decade (aside from short term variations).

· The opposite has been true over the last 3+ decades where interest rates for borrowers have fallen from close to 20% in the late 80’s to less than 2% in early 2021.

Shares vs property – the last 3 decades with falling interest rates

· Over the same period (last 3+ decades) both Australian Shares and Residential property have achieved strong capital growth at a comparable scale to each other.

· Net income from holding these assets has been markedly stronger for stocks (dividends versus net rent from property has been close to double). Perhaps this compensates the investor for the heightened short-term volatility of the stock market.

· When both sources of investor return are accounted for (growth + income) stocks are ahead, but from a capital growth perspective alone, performance has been very similar.

The broad effect of interest rates on Asset Values

· Falling interest rates lowers the cost of borrowing (for both mortgage holders and businesses) but mortgage holders tend to be in far more debt when compared to asset values, than businesses. Falling interest rates make the cost of borrowing cheaper and so has a stimulatory effect on price growth, but particularly for property prices where much more debt is held.

· Falling interest rates on the back of lower inflation tends to have a depreciatory effect on revenue growth for businesses and therefor profit margins. This in turn has a deflationary effect on stock valuations.

· Conversely, increasing interest rates increases cost of borrowing, having a depreciatory effect on price growth for residential property

· Increasing interest rates (on the back of higher inflation) can have a stimulatory effect on revenue and profits, and therefore a stimulatory effect on businesses and share prices.

History can be a good guide but not infallible. There’s no guarantee that inflation and rates WILL rise. But if indicators come to fruition, the next decade might see a divergence between the rates of return on share prices and residential property prices with stocks or shares possibly having the upper hand.

Sean Atkins

Principal and Senior Advisor