This has been a perennial question for Australia. There has been much discussion over a number of years about whether Australia’s house prices are too high, and indeed whether there is a house price ‘bubble’. This notion is typified by the Economist magazine’s regular update suggesting that Australia’s house prices are up to 50% overvalued against standard naïve measures.
Our view is that these metrics are indeed too naïve to be useful. Typically they take a measure of housing prices to income or to rents and compare the current level to a 15- or 20-year average. This ignores a large structural adjustment that occurred in the Australian housing market between 1997 and 2003. This transition involved (1) lower interest rates, (2) better-anchored inflation expectations, and (3) increased availability of housing credit (Bloxham and Kent 2009). Without some reversal of these structural changes – which is a virtual impossibility – we do not expect Australian housing prices to fall.
Indeed, we expect them to track sideways in the short term and then rise in line with household disposable incomes – consistent with recent history. Since late 2003 the dwelling price to income ratio has been broadly stable at between 3½ and 4½ and has averaged 4 (Chart 35). As we are forecasting growth in household disposable income per household of around 5% per annum over the next couple of years (as a result of strong employment and wages growth), we also have in mind that house prices will grow at this pace over the next couple of years.
Supply features of the housing market support this assessment. Most forecasters, including official agencies, suggest that Australia has an undersupply of housing. This assessment is most simply made by comparing growth in the number of dwellings to population. As we pointed out above, since 2006, population growth has exceeded new supply of dwellings, which is the first time this has happened in the postwar era. This will put a floor under housing prices and is a key reason why we have little concern about a sharp (or large) house price decline.
More fundamentally, we do agree that housing is fairly expensive in Australia, though we see good reasons for this.
First, the quality of the housing stock is high. Australia has the largest dwellings in the world, and they are of high quality. Estimates suggest that the average Australian dwelling is 214 square metres, and real expenditure on new dwellings is now 60% higher than it was 15 years ago, reflecting the increase in both the size and quality of dwellings.
Second, well-located dwellings are in particularly limited supply. This reflects that most dwellings in Australia are on relatively large blocks of land, there are fewer apartments in Australia than in many other nations (particularly in the suburbs close to city centres), and there is little appetite from local government authorities for significant change in this regard.
Third, public transport from outer suburbs in most cities is generally of fairly low quality, limiting the distance which people can productively live from the city centres and further enhancing demand for property in the centre of the cities.
Lastly, there is a lack of affordable land at the fringes of major cities. This is due to state governments seeking to front-load infrastructure costs into the land release price and also some issues with land investors holding large swathes of land in anticipation of future capital gains – and not being prepared to sell this land in adequate quantities in the short run to meet demand.
Importantly, despite relatively high levels of household debt in Australia, the households that hold this debt can still service mortgages. Less than 1% of mortgages are in arrears in Australia, which is internationally low. This of course reflects that the Australian economy had a relatively mild downturn, with housing prices falling only 3% in 2008 before rising around 20% over 2009 and early 2010 and levelling out subsequently. It also reflects that the unemployment rate has remained relatively low.
However, there are other reasons why levels of household debt should not be a large concern. The key one is that 75% of all household debt in Australia is held by the top two-fifths of income earners. If we look even deeper, we find that only a small proportion of households are truly in a vulnerable state regarding their ability to continue to service their mortgages. Vulnerable households – in this case, ones that have a loan-to-valuation ratio of 90% or above and also use more than 50% of their disposable income to service their mortgages – constitute less than 2% of all owneroccupied households with debt in Australia.
Slower housing credit growth in recent years, due partly to lower housing turnover, has also meant that the Australian mortgage book is ageing. This reduces the risk of repayment problems, as households with a longer history of repayment tend to be better risks. The credit foncier model of repayments suggests that these households are now repaying a greater amount of principal and less interest, so that households have built up equity in their homes and could run this down in a crisis.
The structure of the mortgage market and tax system in Australia is also such that most households are ahead of schedule in their mortgage repayments. This would provide a buffer in the case of a negative income shock to households, such as increased unemployment.
In the event of a large negative shock to the Australian economy, there are also a number of contingencies built into the system that would somewhat protect the housing market. These were vividly displayed during the GFC. The RBA would cut interest rates, the fiscal authorities would boost spending, and the exchange rate would depreciate. As we discussed above, with most of the mortgages at variable rates, the monetary transmission mechanism is very powerful, and very low net government debt – it is forecast to peak at 6% of GDP in 2012/13 – means the government also has significant capacity to spend.
Overall, with strong prospects for the Australian economy, on the back of high commodity prices driving a mining investment boom and rising incomes, we expect that housing prices will continue to grow at a modest pace over the next few years. We view the risk of a sharp fall in housing prices as very low.
