Australian house prices are 30 per cent undervalued, the widest such gap in three decades, according to Reserve Bank senior research manager Peter Tulip.
Now that statement is going to create some controversy isn’t it?
Delivering the preliminary research results to a session on housing at the Australian Conference of Economists in Brisbane recently, and stressing that they should be attributed to him and not the bank, Tulip said that whereas a year ago home prices were “fairly valued”, today they are about “30 per cent undervalued”.
It’s all to do with interest rates
The change has been brought about by much lower mortgage rates and by changes in bond prices that imply mortgage rates will hug their present historic lows for a further decade.
The latest Core Logic figures show nationally property values are up 10% over the last year, with Sydney house prices have climbed 16.2 per cent and Melbourne property prices 10.2 per cent
Despite this Dr Tulip and his co-author, Ryan Fox, argue that rising prices say nothing about whether home ownership is good value compared with the alternative, which is renting.
He told the session:
“We find that owning a house costs 30 per cent less than renting.
That is, houses are 30 per cent undervalued.
Another way of interpreting our results is to look at the expectations underpinning current house prices.
Our results suggest that those expectations currently look fairly reasonable.
They do not show unusual optimism, they do not show irrational exuberance.
But this hasn’t always been the case.
Just one year ago when we last published results, we found that houses were fairly valued — that is, the cost of buying was about the same as the cost of renting.
What has changed since then is that real long-term interest rates have fallen substantially.
That fall made housing more attractive relative to renting, despite the increase in prices.”
It’s cheaper to buy than rent
Dr Tulip said the annual cost of renting was likely to be 3.9 per cent of the property’s value, compared with 2.7 for owning.
His research compared the cost of renting and buying identical properties, avoiding the common error of comparing national average rents with national average prices.
Because owned homes are typically “bigger and nicer” than rented homes, a lot of the apparent price difference reflects a quality difference.
They calculated the annual cost of a bought home from the purchase price, the transaction cost, the expected mortgage rate and the running and depreciation costs offset by expected capital gains.
The research shows that owning a house is 30% cheaper than renting – but that doesn’t mean that houses are 30% undervalued.
However it’s another nail in the coffin of those waiting for the property bubble to burst.
If you want to know why I say this please read: Australia’s Property Bubble – the smart investors guide
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