In 2017, the Collins Dictionary Word of the Year was "fake news," infamous by then-US President Donald Trump. With real estate being Australia's most popular asset class, some reviewers find it easier to gain attention by engaging in controversies and alternative facts. Titles like 'bricks and felling' come to mind. As 2021 sees record real estate prices and borrowing, the usual suspects will undoubtedly shift the conversation to a real estate bubble sooner or later. Today we're going to detail some of the more common claims about whether Australia is in the middle of a real estate bubble.
The Australian real estate market?
First, let's put some perspective in defining the Australian real estate market. Australia is one of the most urbanized countries in the world. So urbanized, in fact, that 40 percent of our entire population is in a hurry in the major cities of Sydney and Melbourne. To put this into perspective, 25 percent of Canadians live in Toronto or Montreal, 21 percent of Britons live in London or Manchester, and only four percent of the United States live in New York or Los Angeles.
Sydney and Melbourne are not only the most populous parts of the country. They are also the location of the greatest concentration of expensive homes. Although 40% of home sales over the past decade have been in Sydney and Melbourne (according to ABS data), cities contain an even higher proportion of the country's home values. Think of it this way: the median house price in Sydney is almost double that in Perth. This means that even though Sydney has 2.3 times more housing than Perth, the total price of housing is about 4.3 times more.
How does it work mathematically? If Sydney's median house price fell by just one percent, Perth's would have to rise 4.31 percent to balance the national figure (assuming, for the purposes of this exercise, that all other markets remain. unchanged). If Perth grows in place of, say, 3.5%, then the headline would be “Declining National Housing Values”. Although the only market that fell in values ??was Sydney.
This hypothetical scenario has actually played out in different ways recently. After Sydney passed its peak in 2017, the total value of Australia's housing stock began to decline despite regional housing prices in Victoria, Brisbane and Hobart rising. The same was true of semi-detached dwellings in a number of markets.
Not all markets in a country act the same
What we have discussed so far clearly raises the problem of tarring an entire country with the same brush. It's not just a problem in Australia. Even during the most infamous real estate bubble in generations – the subprime mortgage crisis in the United States – the markets operated in stark contrast to each other. At one end of the spectrum, you have Miami. This market has followed the narrative fairly well. There, the house price index skyrocketed between 2004 and 2007, only to then collapse. Prices have since recovered and passed the peak of the bubble. New Haven (of Yale fame), however, grew nowhere near as strong before the GFC, but still hasn't fully recovered from the crisis. On the other end of the spectrum, Austin experienced little more than a slowdown during the downturn and has since outperformed the other two markets.
In the case of Australia, exhibitors of the housing bubble typically identify one or a combination of the following: increasing levels of household debt, price-to-income ratios, price-to-rent ratios, and prices per square meter. Let's unpack a few of them in a bit more detail.
Household debt
According to OECD statistics, Australia has the fifth level of household debt as a percentage of net disposable income of participating countries. We are behind Denmark, Norway, the Netherlands and Switzerland. Not far behind us are South Korea, Luxembourg, Sweden and Canada. A number of these countries were featured in a 2020 report compiled by the RBA, exploring the various causes of the growth in debt-to-income ratios. These include income growth, financial deregulation, interest rates, the age structure of the population, as well as homeownership rates.
I have spoken before about the relationship between financial deregulation, income and interest rates when it comes to the future of the Sydney real estate market. So in this article, I want to take a little more interest in home ownership. It has been a hot topic in recent years, serving as a catalyst for the negative gear debate in the recent federal election. The Labor Party's argument was that negative debt made it harder for homeowners to compete in the market, putting downward pressure on homeownership rates. This argument does not stand up to scrutiny. At PropertyAnalyst.net, I compare homeownership rates between a number of jurisdictions via an interactive graph. You will notice that a reduced proportion of private landlords are usually replaced by social housing rather than a noticeable increase in home ownership. Apart from that, the rise of residential real estate investment funds offers institutional investors the opportunity to bypass these kinds of government policies, which once again means that the losers are the entry-level real estate investors. range. Take the UK, for example, where house prices have recently reached record highs despite constraints on tax benefits for direct property investors.
If we are to compare household debt levels in Australian capital cities, the differences between them are larger than the difference between Australia and many other developed liberal economies. According to the ABS Income and Housing Survey 2017-2018, the average level of household debt was $ 270,800 in Perth. It was just $ 118,700 in Hobart. Since the differences in disposable income between the two cities are not as large, this translates into a considerable disparity in the ratio (which you can see in the graph below). Lumping Perth and Hobart together in the same general commentary regarding Australian household debt makes virtually no sense from a real estate investor's or homeowner's perspective.
Housing affordability
It's no secret that house prices in parts of Australia have skyrocketed in recent years. In 2015 and 2016, the historically working-class suburbs of western Sydney surpassed the median house price threshold of $ 1 million and more and more people began to wonder if Australian homes were unaffordable. The main international measure of housing affordability is known as the price-to-income ratio. This is a simple division of the median house price by the median annual household income. If the median real estate price is six times the median annual household income, the price-to-income ratio for that area is six. The higher the price / income ratio, the less affordable housing is considered. Even though this seems like a simple calculation, it is sorely misunderstood. This has led the OECD to commit to offering these statistics at the regional level from 2020, on the assumption that there are significant variations between markets within the same country.
Australia is a classic case of price-to-income ratios varying widely between suburbs, cities and regional markets. For the purposes of this analysis, let's compare the neighboring eastern suburbs of Sydney to the Australian housing price-to-income ratio on census night 2016. East Sydney is an area of ??interest. It's known throughout the county as the home of Australia's wealthy elite, with names like Malcolm Turnbull, Justin Hemmes, the duo Kyle and Jackie-O, as well as (formerly) James Packer. However, it's also home to a host of ambitious millennials, college students, and backpackers. Despite the diversity, most of Sydney's eastern suburbs have some of the most expensive and in-demand accommodation in the country. In Vaucluse, you would expect to part with over $ 5 million to buy the middle house in this suburb. In 2016, at the time of the last census, that figure was closer to $ 4.5 million. At that time, the price-to-income ratio of houses in the suburbs was a dreadful 31.6 compared to 7.2 in Australia. For comparison, I've included a few nearby suburbs in the table below.
What is unique about the Eastern Suburbs are the significant levels of personal wealth within some of these households, which means that the median income is not as efficient as the distribution of wealth for determine the affordability of housing in this area. Additionally, houses represent a considerable premium over apartments in these areas due to the stark contrasts between these two housing types (you don't compare a fibro chalet with an apartment, you compare a mansion with an apartment). The occupants of each type of property will differ considerably in terms of the distribution of income and wealth. Much like the eastern suburbs, many other Australian streets, suburbs, regions and states have unique characteristics that affect price-to-income ratios without necessarily reflecting housing affordability.
East Sydney serves as a warning about the limits of house price-to-income ratios. After all, the middle household doesn't buy the middle house in many parts of Australia. In the case of eastern Sydney, almost half of all homes are rented and a quarter are under mortgage. Despite very high price-to-income ratios, mortgage stress was lower in this area than the national average. What do all these numbers mean? The large variation in wealth and income in this area skews the house price-to-income ratio beyond anything that is significant.
So, is there an Australian real estate bubble?
There are definitely a few pockets of Australia pushing housing prices into bubble territory. For these markets, it is likely that they will experience a prolonged stagnation in price performance once new price growth catches up with discounted mortgage interest rates. Areas of particular concern to me are the high-debt, middle-to-low-income neighborhoods that are susceptible to any increase in mortgage interest rates throughout the life of their loan. A number of them can be found inside Greater Sydney. When it comes to everywhere else, keep in mind that it probably differs from the national numbers you hear about online and in the news.
In summary, instead of thinking of an Australian real estate bubble per se, we should be thinking of specific areas where it does not make sense to buy on the basis of exposure to potential future economic events such as changes in income, employment, demographics, as well as access to credit. As an investor, you can alleviate this problem by checking out the level of mortgage stress in the area and determining whether locals could face mortgage interest rates returning to their historical averages to medium and high. long term.
Luke J. Graham is a real estate market and behavior analyst currently conducting research and postgraduate studies in these disciplines at the University of Oxford. Recently, this has included work on housing affordability in large cities, the future of automated assessment models, as well as the behavioral economics of environmentally sustainable housing. He is a consultant to business leaders and real estate entrepreneurs in Australia and abroad through his platform PropertyAnalyst.net.
