The House price indexes from the Australian Bureau of Statistics for the March quarter this week showed a 1.1% rise, to take the rise for the year to March to nearly 14%.
In Melbourne it was up 25%, and 20% or more in Brisbane and Adelaide.
Rising interest rates and a rise in mortgage stress to record levels has led to a deterioration in the outlook for house prices at a time when Australian housing remains very overvalued, affordability is terrible and low rental yields make housing less attractive for investors.
While the housing shortage and the low likelihood of a recession should prevent sharp falls in Australian house prices, modest falls are now likely over the year ahead, according to this forecast from the AMP’s chief strategist and economist, Dr Shane Oliver.
After several interest rate hikes and increasing evidence the Australian housing market is softening, the outlook for house prices has deteriorated.
Some are still talking about big gains on the back of the shortage of housing whereas others are talking about up to 30% declines in house prices as overvaluation and excessive debt levels are unwound as the economy deteriorates.
The picture in the US where house prices are off 15% from their peak and in the UK, parts of Europe and New Zealand where house prices are starting to fall suggest reason for concern for Australian house prices.
Australian house prices vulnerable
There are good reasons to believe that Australian house prices are vulnerable to falls over the next year or so.
The first point to note is that the surge in Australian house prices over the last decade has been far bigger than in the US. As indicated in the chart below US house prices went up three fold over the last twenty years but Australian house prices went up five fold.
Secondly, and more fundamentally, the huge surge in Australian house prices has left them very expensive and overvalued. In real terms (after removing the impact of inflation), Australian house prices have gone from well below trend in the mid 1990s to well above, where they remain at now 32% above trend. See the next chart.
The surge in Australian house prices over the last decade has led to a near doubling in the ratio of average house prices to average household disposable incomes (see second chart below), low gross rental yields (just 3.1% for houses and 4.4% for units which is well below the 6% plus net rental yields available on directly held commercial property and the 7% plus distribution yields on listed property trusts) and a record low for housing affordability.
On our estimates, on a range of indicators Australian housing is about 30% overvalued.
Internationally, Australian housing is amongst the most expensive in the world with a ratio of house prices to median household income which is roughly double that in the US. With Australian mortgage rates around 9% (using the basic variable rate) and US mortgage rates around 6% (using the standard US 30 year mortgage rate), Australian housing affordability is particularly poor.
The surge in Australian house prices relative to income levels has gone hand in hand with a massive rise in household debt, as evident in the next chart.
This is not to say it’s the rise in debt that has caused the rise in Australian house prices relative to income levels, although it has probably played a role.
Household debt has also increased in the US, UK and other countries but housing in those countries is a lot more affordable. Rather the key drivers of Australia’s poor housing affordability appear to be a combination of restrictive land supply policies and high urbanisation & centralisation (i.e. we have all congregated in a few coastal cities and then put land release barriers around them).
There are numerous US cities which have grown in size as quickly if not faster than Australian cities but where house price to income levels have changed little over the last decade because land supply polices are far more liberal.
Rather the rise in debt has mainly been an outworking of deteriorating affordability on the back of constrained land supply.
This rise in the ratio of debt to income has seen Australia move from the bottom of the pack in terms of comparable countries to near the top. See the chart below.
The combination of overvaluation, poor affordability and very high household debt has left the Australian housing market very vulnerable to anything which discourages buyers or threatens the ability of existing borrowers to service their debts.
Which brings us to the third point, which is that rising mortgage rates – with the threat of more to come if the economy doesn’t continue to slow and if funding costs remain difficult for the banks – are now proving to be a major problem for the Australian housing market.
While Australia does not have the problem with poor lending standards that is now driving a collapse in US house prices, it does have rising interest rates leading to record mortgage stress at a time when household debt and house price to income ratios are very high. This runs the risk o
