Housing bubble, affordability crisis, over-inflated markets, growing million dollar medians…the list of less than flattering descriptions for Australia’s housing market continues to grow as both local and overseas media outlets fuel speculation as to the state of our residential real estate sector.
Some suggest we are heading for a price crash comparable to that experienced in the US during the GFC or more recently, in Ireland where the housing bubble caused a monumental collapse in local property values.
According to a recent report published in British based magazine The Economist, Australian property prices are the most over-valued in the developed world, with the ratio of house prices to rents currently sitting at 56 per cent above the long term average recorded between 1975 and 2010. Coming in a close second was Hong Kong, where house prices are 54 per cent above the historical average.
The index is created using a ratio of house prices to rents (based on data supplied by RP Data-Rismark), which assumes that rents paid by tenants on a monthly basis should reflect the prices people pay for housing.
It’s all too simple
Discussion about whether house prices are overvalued and then calculating ‘by how much’ by just measuring one parameter as The Economist and many other commentators has makes the assessment inaccurate.
You could simply say Australia tops The Economist list because our average rents are too low – because until recently almost anyone who wanted to buy a house could afford to do so.
House prices reflect a complex set of influences on both the demand and supply sides of the market which means it is clearly wrong to compare the “affordability” of housing from one country to another on a single parameter. Various countries have different banking systems, lending policies, interest rates and tax breaks for homeowners or investors.
Yet what The Economist is trying to do is to simplify the situation which is fluid and dynamic and assume it should revert to the long-run averages and then they imply that the discrepancy represents ‘over-valuation’.
Undersupply holding up values
One big difference between Australia and many overseas countries is our undersupply of properties. As the Reserve Bank observed recently, “over recent years, the rate of increase in the number of dwellings has been below the average of the past 50 years. In contrast, the rate of increase in the population has been around the fastest in 50 years.”
Continuing difficulties with the supply side are likely to push average house prices higher. Again to quote the Reserve Bank: “If we are to build more dwellings, we need to ensure that planning guidelines and infrastructure provision can accommodate this. This will pose challenges for all levels of government.”
So who is right?
Recently Reserve Bank Governor Glenn Stevens said he was not ‘terribly troubled” about the level of house prices in Australia stating the ratio of income to house prices in Australia was “not exceptional by global standards.” And many local economists agree, however others, such as GMO chief investment strategist Jeremy Grantham and even the International Monetary Fund, beg to differ.
Adding fuel to the debate, author of The Economist report Andrew Palmer said, “There may be good reasons for Australian prices to have risen so far, but people made similar, and ultimately incorrect, arguments for the run-up in prices in the West.”
Some have suggested that the recent slow down and slight fall in values across many of our markets is a sign of worse to come, with negative growth apparently being some harbinger of doom rather than a normal cyclical correction.
However AMP Capital Partners economist Shane Oliver, said although The Economist had been predicting the collapse of Australia’s property market for about eight years, “it hasn’t collapsed yet.”
He argues that continuing strong immigration and a dwelling undersupply is keeping the sector stable and says of growing concern surrounding affordability, “The Reserve Bank is well aware of it and would raise interest rates if house prices start going up again.”
I believe that what we are seeing is simply another swing in the cyclical motion of the property market and the notion of comparing Australian housing to the continuing misfortunes of US real estate is like comparing apples and oranges.
What could cause a crash?
Oliver says the one potential catalyst for a price crash would be if the mining boom and good fortunes of our resources sector suddenly came to a halt.
“If the mining boom came to an end and lots of people lost their jobs and couldn’t serve their mortgages – that would be a trigger (for prices to fall),” he said.
Will property prices fall?
In a recent report Mr Ange Montalti Senior Economist at the ANZ Bank suggested we should just ‘cut to the chase’ and rather than just saying Australian house prices are overvalued, we should ask the more interesting and relevant question: ‘willAustralian house prices fall?’
He said; “It is easy to make a claim that house prices are overvalued by, let’s say 20%, 40% or even 50%, particularly if the statement is then qualified with “we don’t think prices will actually fall by this much”.
Montali said: “To suggest there is overvaluation begs some questions:
• Why has it persisted?
• What is inhibiting the correction?
• If there is going to be a correction, will prices fall by some, all or more than the extent of over-valuation?
• When can we expect the correction?
• What happens after the correction?
• What ‘information’ has the market overlooked that the analyst is so sure about?
The ANZ report suggests that the more you think about it, the more you realise that the concept of “overvaluation” is misunderstood or at least not fully appreciated and therefore generally misrepresented.
“It is more sensible to solve for what will happen and not what should happen. To do so, one needs to recognise both the value and limitations of the more useful commonly applied metrics and then overlay some of the less quantifiable and in some cases non quantifiable drivers.
“Encouragingly, many analysts measuring ‘overvaluation’ do qualify their conclusions and by so doing implicitly or explicitly acknowledge that what actually happens to house prices is driven by forces other than those used to calculate their estimate of overvaluation.
“The problem in the debate is that these ‘other forces’ are often conveniently ignored or discounted as either insignificant or irrelevant. This is central to why there are disparate views about the future of house prices.
The ANZ report then goes on to explain that Australian house prices are at the level they are today because of a combination of structural changes to our credit system that mean that reverting back to long term averages is inappropriate and a shortage of dwellings. For example, the ANZ feels that deregulation of the banking system; increased customer sophistication and credit product innovation means that things won’t ever be the way they were in the past. And at the moment above average population growth, plus below long term average dwelling construction is causing a shortage of dwellings that are underpinning property values.
What many commentators seem to be forgetting is that the fundamentals that have worked against American property prices – an overall weak economy, high unemployment, a dwelling oversupply and dicey lending practices, are the exact opposite of the fundamentals currently driving Australian bricks and mortar. And it is this disparity and our continuing good economic fortune that will see our housing market hold firm into the future.
What we are really seeing is property prices justified by living in one of the best economies in the developed world. What is often forgotten by overseas analysts is that most of us want to live in much the same place in our four big capital cities, all on the coastline. Should there not be a premium on this type of lifestyle?
It’s the price you pay for living in the best country in the world.
Now don’t get me wrong…I’m not suggesting prices will keep booming – clearly they are not. But there’s no property crash on the horizon either.
So what is a property investor meant to do?
Well one thing that’s important if you want to know the right thing to do is to get independent, unbiased information to allow you to have the right perspective on what going on.
In other words…you have to listen to the right people.
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