Are Australian House Prices Overvalued? By Martin North October 1, 2015 LINK
Within the 65 pages of the IMF report there is a comprehensive section on Australian house prices. Housing market risks they say remain heightened. They conclude that house prices are moderately overvalued, probably around 10 percent. The problem is concentrated in Sydney and is fuelled by investor credit and interest only loans. Current rates of house price inflation imply rising overvaluation. Current efforts to rein in riskier property lending might not be sufficiently effective.
International comparisons persistently signal warnings. The level of real house prices and the house price to income ratio is high relative to the OECD average (though similar to other buoyant markets). House price inflation picked up to 7-10 percent in 2014-15—driven by rapid increases in Sydney and to a lesser extent Melbourne (prices in the resource states have fallen back in recent months). While foreign investment in real estate has increased, the main driver has been local investor lending and interest-only loans. Sydney house price to income ratios are much higher than for other cities at around 7—similar to Auckland, London, Stockholm and Vancouver.
Can the increase in house prices be explained?
The housing market and financial system have changed significantly over the past two decades with a shift to low inflation, low nominal interest rates and financial liberalization which loosened credit constraints. Households’ borrowing capacity increased and they moved to a higher steady state level of indebtedness and higher house prices relative to incomes. Supply side constraints may also keep prices high. Although Australia is big, much of the country is remote and the population is concentrated in a few cities where there are geographical or other barriers to expansion. Population growth has also been much more rapid than for other OECD countries, whereas housing investment as a share of GDP is only at OECD average levels. Supply bottlenecks also reflect planning issues and transport restrictions.
Are high and rising prices a problem? There has been no generalized credit boom and lending standards are generally high (and being tightened), so financial stability risks seem contained. The run-up in house prices has also not been accompanied by a construction boom (unlike Ireland and Spain). But with already high debt and house prices, rapid house price inflation raises the risk of a sharp reversal, which would damage the macroeconomy.
Do models point to overvaluation? Estimating overvaluation is inherently difficult. Rather than relying on one model, staff used four different approaches.
Statistical filter. Deviations from an HP filter suggest overvaluation of about 5 percent. Fundamentals. The standard model used in the Fund, estimated since the early 2000s, with fundamental explanatory variables—affordability, incomes, interest rates, and demographics―estimates overvaluation of around 15 percent and equilibrium growth rates around 3-4 percent. Including supply factors. A model using similar longrun fundamentals, but adding credit and the housing stock to take into account supply constraints, points to an overvaluation of around 8-10 percent. User costs. Estimates of user costs (whether it is more expensive to own than to rent) suggests that renting is about as costly as buying a house based on average real appreciation since 1955 (Fox and Tulip, 2014). However, this estimate is highly sensitive to interest rates and expectations of future house price appreciation. Using a plausibly lower expected appreciation term results in an overvaluation of 10-19 percent.
Bottom line: House prices are moderately overvalued, probably around 10 percent. The problem is concentrated in Sydney and is fuelled by investor credit and interest only loans. Current rates of house price inflation imply rising overvaluation.
In their house price modelling, they assume a baseline projection is for a soft landing, with house price inflation slowing to a sustainable 3-4 percent, based on medium-term fundamentals. This implies no change in the estimated overvaluation and housing market risks thus remain heightened.
Current efforts to rein in riskier property lending might not be sufficiently effective. Against a backdrop of already high house prices and household debt, this could give rise to price overshooting and excessive risk taking. A sharp correction in house prices, possibly driven by Sydney, could be triggered by external conditions (e.g., a sharper slowdown in China or a rise in global risk premia), or a domestic shock to employment.
This might have wider ramifications if it affects confidence. The house price cycle could be amplified by leveraged investors looking to exit the market and a turning commercial property cycle. Though currently small, investors in self managed superannuation funds that have added geared property to their fund portfolios would also be adversely affected in a downturn. In a tail scenario, APRA’s stress tests suggest banks would probably face ratings downgrades/higher offshore funding costs and would likely resist capital ratios falling into capital conservation territory by sharply tightening credit conditions, thus transmitting and amplifying the shock to the rest of the economy.
Any expressed market opinion is my own and is not to be taken as financial advice
Frightening. No doubt this will be picked up the media and everyone out in the burbs will feel pretty good to hear that an organization such as the IMF have estimated that house prices are only overvalued by approx 10%. Chances that few people will actually read the report and understand what it really means.
So according to the IMF, an increase in the iron ore price has a strong impact on the terms of trade (go figure), but the likelihood of that happening is low. In that case, a collapse in iron prices probably has meaningful impact as well.
Export or services to Asia will have a medium impact, but also the likelihood is low. According to the nation's guardians, I thought we stand to make a motza from education.
Most importantly to the burbs, the IMF thinks that the likelihood of a hard landing in property is "medium", but the impact is going to be high. Make of that what you will kids.
In a similar vein, weak domestic demand and weak growth in China is seen as medium likelihood, but with those pesky high impacts.
So according to the IMF, an increase in the iron ore price has a strong impact on the terms of trade (go figure), but the likelihood of that happening is low. In that case, a collapse in iron prices probably has meaningful impact as well.
Export or services to Asia will have a medium impact, but also the likelihood is low. According to the nation's guardians, I thought we stand to make a motza from education.
Most importantly to the burbs, the IMF thinks that the likelihood of a hard landing in property is "medium", but the impact is going to be high. Make of that what you will kids.
In a similar vein, weak domestic demand and weak growth in China is seen as medium likelihood, but with those pesky high impacts.
It must be my glasses - I read that as "In their house price modelling, they assume a baseline projection is for a soft landing, with house price inflation slowing to a sustainable 3-4 percent, based on medium-term fundamentals."
Any expressed market opinion is my own and is not to be taken as financial advice
It must be my glasses - I read that as "In their house price modelling, they assume a baseline projection is for a soft landing, with house price inflation slowing to a sustainable 3-4 percent, based on medium-term fundamentals."
Yes, but you didn't read the report. Like most burb dwellers, you're only privy to what is filtered for you.
It must be my glasses - I read that as "In their house price modelling, they assume a baseline projection is for a soft landing, with house price inflation slowing to a sustainable 3-4 percent, based on medium-term fundamentals."
It's not your glasses that are the problem it's your mindset, and your mind is set on the Australian property market returning to the norms of the 70's 80's 90's and 2000's. That was an anomolous period in history, a period of high debt inflation that may never be repeated.
Look at the 130 year chart and compare it to the debt chart below. Soon mortgage brokers wont be needed, what few loans that will be written will be done in-house by banks. And all the blame for all this mal-investment will be heaped onto the independent brokers who created it.
"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works." John Stuart Mill
Fundamentals huh. What fundamentals? How does a house that costs $2 million, and only generates $50K a year in net rent, with an ROI of less than 3%, represent a fundamental? The people who write these reports seem to think that fundamental is some historical line on a chart.
In other news Malcolm Turnbull has flagged changes to CGT and negative gearing.
Reserve Bank calls for negative gearing, capital gains tax review Posted July 16, 2015
The Reserve Bank says there is a case for reviewing negative gearing, especially its interaction with the capital gains tax discount as a tax minimisation tool. In its submission to the House of Representatives Economics Committee's inquiry into home ownership, the Reserve Bank observed that a lower proportion of young Australians own their own home now than in previous generations.
"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works." John Stuart Mill
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