I was particularly thrilled to see the Deputy Governor supply some refreshingly insightful analysis on international ‘house price-to-income ratios’, which is a matter close to our hearts and fully validate recent remarks I made in my presentation to the Melbourne Institute.
In the latter missive I criticised comparisons of absolute house price-to-income ratio ‘levels’ across countries (as opposed to more accurate evaluations of changes in growth rates over time, which is the preferred approach of the IMF). I also noted two further mistakes that government economists, market analysis, and media commentators have made apropos Australia’s house price-to-income ratios:
Mistake 1: they forget that 40% of all homes in Australia are not located in the capital cities (based on the 2006 census data);
Mistake 2: they forget that 25% of all homes are not houses—they are semis, terraces, apartments etc (based on the 2006 census data).
When RP Data-Rismark analyse all-dwellings in all-regions, Australia’s median dwelling price is only circa $370,000 (ie, not the $500k often quoted).
In my presentation to the Melbourne Institute a few weeks ago I considered the question of how inflation-adjusted ‘house price-to-income ratios’ had varied over time using the latest IMF data.
The figure below shows the IMF’s estimate of changes in house price-to-income ratios from 13 OECD countries including Australia over the period 1997 to end 2008.
It is noteworthy that the more recent period arguably disadvantages Australia since home values here fell only modestly in 2008 whereas they experienced precipitous falls elsewhere.
On the basis of this benchmark, changes in Australian housing costs have been demonstrably ‘middle-of-the-road’. More precisely, between 1997 and 2008 Australia’s house price-to-income growth was lower than the following peers:
–The UK;
–France;
–Sweden;
–Spain;
–The Netherlands; and
–Ireland.
Australia’s house price-to-income growth between 1997 and 2008 was only slightly higher than that which was realised in Italy, New Zealand and Norway. (The two clear international laggards were Canada and the US, as the Deputy Governor points out.)
Source: IMF (Click to enlarge)In my Melbourne Institute speech I argued that that one cannot make accurate comparisons of house price-to-income ratio levels across countries as observers often try to do. This is exactly why the IMF focuses on changes in house-price-to-income ratios over time rather than the absolute levels. If one does compare the levels, one tends to arrive at rather bizarre conclusions, such as those proffered by the Demographia survey, which claims that housing in Bundaberg is less affordable than housing in New York in London! Absolute comparisons of house-price-to-income ratios do not work because of wide differences in international:
– House price collection and measurement methodologies;
– The legal and tax treatment of housing;
– Home ownership rates;
– Urban densities;
– Population growth rates;
– The distribution of disposable incomes; and the
– Economic characteristics of the representative home owner.
I also discussed the latest RBA data on international mortgage default rates (see below). Here I observed that default rates are the best possible indication of true financial stress as opposed to other metrics, such as mortgage repayments as a share of household disposable income.
On average over the last circa 22 years, mortgage repayments in Australia have typically absorbed 30-35% of household disposable income. Misleading mortgage stress benchmarks that claim that households are under financial pressure when they pay away more than 30% of their disposable income to service their home loans therefore imply that more than half of all Australian borrowers have always been in mortgage stress.
Yet on the basis of the RBA’s data, only 0.66% of all Australian home loans are in genuine arrears, which implies that of the 4-5m households with a mortgage less than 40,000 are in serious stress. Importantly, this is just 12% of US levels and 22% of UK levels. Once again, this also implies that the cost of housing in Australia is not engendering serviceability problems, at least by international standards.
Source: RBA (Click to enlarge)While I do not have time to do full justice to Ric Battellino’s speech right now, I will draw attention to some of his more choice observations:
“There is a common perception that house prices relative to household income in Australia are high both compared with other countries and with our own history.
It is certainly the case that the ratio of house prices to income in Australia is higher now than it was 20 years ago. However, this is largely explained by the fact that the fall in inflation over that period has allowed nominal interest rates to cycle around a lower average level now than was the case earlier. That is, lower interest rates have allowed households to take out bigger home loans, without increasing housing loan repayments (Graph 8). In turn this has given households more buying capacity in the housing market, which has been reflected in house prices.(Click to enlarge)
International comparisons of the relativity between house prices and income have been the subject of considerable research over the years. One of the complications faced by people working on this topic is to ensure consistency in the data that underlie the comparisons. Do the figures relate to capital city prices, or the prices across the whole country? Do they cover all dwellings or just detached houses? Is income measured as average weekly earnings or average household income? It is not always possible to get entirely consistent data across countries, so we need to be careful in interpreting the results of these comparisons.
Most people do agree, however, that the ratio of house prices to incomes in Australia is higher than in the United States. One explanation that has been put forward for this is that the Australian population is more concentrated in a few large cities, where house prices are higher, even relative to income. This seems like a plausible explanation, but there must also be a financial explanation, otherwise we would expect to observe that housing stress among Australians was higher than in the United States, and this is clearly not the case. Arrears rates on housing loans in Australia have typically been lower than those in the United States, despite the higher ratio of house prices to income.
There are a couple of reasons why Australian households seem to be able to sustain a higher ratio of house prices to incomes. First, Australians seem to spend less of their income on non-housing consumption than is the case for US households, with a significant part of this difference explained by lower health costs in Australia. Australian households therefore have greater capacity to service housing loans. Second, the level of gearing in the United States housing market is noticeably higher than in Australia. This may reflect the fact that Australian households are more active in paying down their loans after buying a home, possibly because owner-occupied mortgage interest rates are not tax deductible here as they are in the United States. The faster pay-down of mortgage debt in Australia reduces the risk of borrowers subsequently getting into financial difficulty.
Overall, the experience of the last few years suggests that the Australian household sector as a whole appears to have the financial capacity to sustain a relatively high ratio of housing prices to income. That capacity may not, however, be evenly distributed through the population. Many 50–60 year olds, having benefited from the prolonged economic expansion over almost 20 years and the accumulation of superannuation savings, are in a strong financial position. This has encouraged a change in financial behaviour, with many households in this group being more inclined to stay geared up later in life, using the funds to upgrade or expand dwelling investments. It is likely that this changed behaviour has been a significant factor in the housing developments we have seen over the past 10–15 years.”
