Is Australia’s housing crash upon us?

After the surge in Australian house prices from the mid-1990s into last decade my view was that while the risks of a sharp fall back in house prices were high, the most likely scenario was an extended period of range bound house prices in real terms.

If anything, most of the surprise has been on the upside – although not by much in real terms. But despite the fears of many, house prices have not plunged like those in the US and elsewhere, despite a bigger boom.

However, the risks are rising again. Prices have slid 6% since their 2010 high and worries that the GFC is about to finally catch up with Australian housing are on the rise again. Excessive house prices and the excessive level of household debt that has come with it are Australia’s Achilles heel.

Housing is 60% of household wealth and so movements in house prices have a big impact on household financial wellbeing and spending. Housing credit also amounts to 59% of total private credit, so what happens to house prices is critically important to Australian banks. And as we have seen in Ireland and now Spain, what happens to banks can have a big impact on public debt levels.

Still overvalued, but not by as much

The bad news is Australian housing is still way overvalued. The good news is it is less so, with real house prices going nowhere for the last four years:

• According to the OECD, the ratio of house prices to incomes in Australia is 28% above its long-term average, putting it at the top end of OECD countries, although several other countries are more extreme. The US is now below its long-term average on this measure.

• According to the 2012 Demographia International Housing Affordability Survey, Australian housing trades on a median multiple of house prices to annual household income, which is double that of the US. In Sydney, median house prices are $637,600, compared with $324,800 in Los Angeles. In Perth they are $450,000, compared with $159,500 in Houston, Texas.
• However, it is apparent in the next chart that while real house prices are still above their long-term trend, the divergence has narrowed to 13% from a peak of 33%. Real house prices have now fallen back to 2008 levels.

• Another way of looking at property valuations is to look at the ratio of price to rents (sometimes referred to as a PE ratio for housing) and adjust for inflation. On this basis Australian housing is still overvalued relative to its long-term average by 10%, but at least this is down from a peak overvaluation of 38% in 2003.

The bottom line is while it may not be as stretched as was the case a few years ago, Australian housing is still overvalued. This combined with still high household debt-to-income ratios leaves Australia vulnerable.

Still undersupplied, but maybe not as much

One of the big supports for the Australian housing market is thought to be a shortage of housing, with the National Housing Supply Council estimating a cumulative shortfall of more than 200,000 dwellings. However, the just released 2011 ABS census wiped almost 300,000 off previous population estimates suggesting that the undersupply may not be as chronic as thought, and along with slowing population growth, has potentially reduced a support for house prices.

Our assessment though is that while the undersupply of housing may not be as severe as thought, low vacancy rates still attest to some undersupply. And Australia has not had anything like the residential property construction boom that the US had last decade, which accentuated the downwards pressure on its house prices. In Australia, housing starts and approvals are at cycle lows.