Since the beginning of the Global Financial Crisis in late 2007, Australian dwelling prices have defied many dire predictions. In June 2010, a report by a US-based institution used the ratio of dwelling prices to income to suggest Australian house prices were more than 40% over-priced and that they were among the last major asset price bubbles left to pop after the global financial crisis. In the nervous atmosphere of the time, this report2010 attracted a great deal of attention within Australia and internationally.
However, many local analysts were quick to point out that, unlike the US, Spain and many other countries, Australia had an undersupply of dwellings due to low levels of construction and strong population growth. Housing scarcity is reflected in low reported vacancy rates and apartment rents persistently rising ahead of the inflation rate.
So what has happened since 2010? In nominal terms, house prices are about 3.5% below their mid-2010 level. However, average weekly earnings have grown by around 13.7% over the same period and meant that the average house has become much more affordable on the average wage. Essentially we have seen an orderly deflation in real house prices in Australia.
A December 2012 paper by the Reserve Bank of Australia (RBA) used income data from national accounts to make a consistent and timely cross-country comparison. The paper found that the ratio in Australia was just over four times income, which is consistent with most developed economies that generally range between three and half to five times income. The exceptions are Japan and the US, which are substantially lower.
While dwelling price to income ratios in Australia are now lower than peak levels, they are still well above levels of the 1980s and early 1990s. So are Australian house prices now clear of the risk of a significant rapid correction?
As the RBA point out, there have clearly been structural issues that affected the level of house prices in all advanced countries. A lower inflation/lower interest rate environment has substantially reduced housing finance costs, which have been capitalised into dwelling prices. Increased female labour participation has also increased the proportion of income households can devote to housing costs.
In the absence of an oversupply of dwellings, it would take either a rapid rise in unemployment and/or a steep rise in interest rates to trigger defaults and a significant slump in dwelling prices. Interest rates certainly appear likely to stay low for several years at least. Notwithstanding some current risks to China and the broader global economy, Australian unemployment is forecast to rise only moderately from around 5.5% towards 6% over the next year.
Consequently, the most likely outcome is that Australian dwelling prices will continue to gradually fall relative to household incomes. Eventually, a new cycle of construction that is starting to emerge will lift general housing market confidence and stronger house price growth will emerge later in the construction cycle, but not for at least several years yet.
Leigh Warner is a Director of Research and Consulting for Jones Lang LaSalle, based in Brisbane, Australia.