Property prices in Australia are too high and are facing a steep decline because of the huge gap between income and house prices, according to the International Monetary Fund.
Likening the current cycle to a roller coaster which needs to come down from a steep hump, economist Prakash Loungani told a conference in Washington that Australia was suffering a large distortion between house price values and average incomes, as well as the most significant gap between price-to-rent values.
On average, the previous housing slumps lasted 18 quarters, with prices dropping 22% from peak to trough. By contrast, the current housing slump has lasted only 14 quarters, during which prices have dropped just 15%.
The latest boom though was so much bigger than the previous ones so it is logical to anticipate an even more brutal downturn, Loungani argued. Prices rose 113% over 41 quarters, compared with 39% average price increase over 39 quarters seen in the previous booms.
‘A lot of adjustment has taken place in house prices, so we shouldn’t discount that. It’s true though that we shouldn’t declare victory too soon. We’ve now had a fresh shock from what’s happening in Europe,’ he added.
Looking at prices in OECD countries in 2009, Australia was substantially out of whack with rents and incomes in those countries, compared to average values from 1970 to 2000. In the long run, he argued, incomes and rents will act as weights on home prices, bringing them back to earth.
Australian property analyst Paul Braddick though disagrees and said the price-to-income ratio analysis was ‘fundamentally flawed’ as a measure of housing affordability. ‘International comparisons of house price to income ratios have been widely used to suggest that Australian house prices are significantly overvalued. These analyses explicitly ignore a key component of the housing affordability equation, interest rates,’ said Braddick, head of property at ANZ.
Housing affordability was underpinned by debt servicing levels, of which interest rates were a key driver, he added. ‘Drawing conclusions from simplistic aggregate metrics such as house price to income ratios is very unwise,’ he said.