Are House Prices Overvalued?

Australians love to watch property prices and have become a little alarmed at recent reports that Australian property prices are the most overpriced in the world, next to Hong Kong, according to the Demographia consultancy’s report discussed in last month’s issue.
ANZ recently came out with a report detailing current price movements. It confirmed that median house prices have slowed in most capital cities in 2010 with Sydney prices up around 5pc, Melbourne, around 9pc and Adelaide, 4pc, while Brisbane and Perth fell around 1pc each.In an attempt to analyse the question “Are house prices overvalued?”, the bank broke down the factors that most contribute to rising prices.
One of the most important is rising incomes i.e. what is the link between rising incomes and rising house prices? Similarly, how much do interest rates contribute to price growth.
The chart above (from 1985 on)shows how, if rising incomes alone are factored in (the grey line), then median prices should have grown from a base of $100k in 1985 to $289k in 2010, up 189pc or 4.3pc pa compound. If both rising incomes and interest rates are factored in (the red line), then prices would have climbed to $483k, up 383pc or 9.3pc pa.
In fact, the actual median price of $559k (the blue line) represents an excess of $76,000 or 13pc above the theoretical price. My suspicion is that ease of getting loans from banks is a prime factor in house price growth. Thus, in times of low supply and high demand, as have existed in Australia, the ease of getting a
100pc loan (sometimes more) is a major factor in pushing prices up and could easily account for the unidentified 13pc found by the ANZ, a factor that the bank would be loathe to admit! The ANZ concluded that, notwithstanding the pent up demand for housing and falling population growth, the economic backdrop will remain supportive with ongoing wages growth and falling unemployment while the existing housing shortage worsens with vacancies continuing to climb and rents and yields rising. Which is good news for home owners, but not so good for those looking to buy a home!

George Cochrane