Key housing affordability is wrong, expert claims

House price to income ratios are a misleading method of determining the current state of housing affordability with interest rates being a major factor, an ANZ economist says.

But one property expert disagrees, saying interest rates are irrelevant and the more appropriate measure of housing affordability can be found in relevant international comparisons and disposable income rates.

ANZ head of property and financial system research Paul Braddick said in a report yesterday that while international comparisons of house price to income ratios have been used to show Australian house prices are overvalued, these calculations are “simplistic”.

“Simple house price to income ratios have been widely used to suggest that Australian house prices are significantly overvalued.”

“These arguments centre around the concept of ‘mean reversion’, ie. elevated house price to income ratios must revert to their long-term historical average for ‘affordability’ to be ‘sustainable’.”

Instead, Braddick says, house price to income ratios ignore interest rates, with debt servicing costs being the key driver of affordability.

“This not only means that house price to income ratios are fundamentally flawed as a measure of housing affordability but also makes intertemporal and cross border comparisons of these ratios next to meaningless.”

Braddick points to data showing the median house price to be five times the average household income compared to just three times in the 1980s, with the current median price hovering around $510,000.

“Mortgage interest rates in Australia in the 1980s averaged around 14%, however, since 2000 the average has been close to 7%. This reduction in mortgage interest rates has effectively been capitalised into house prices.”

“The halving of mortgage interest rates almost fully explains the measured rise in the house price to income ratio leaving the house price to income ‘mean reversion’ argument appearing myopic at best.”

But SQM Research founder Louis Christopher says international comparisons are accurate, provided the examples used are comparable in size and context.

“Interest rates vary, they are variable, so it doesn’t matter all that much to the debate. The relevance has to do with a proper measurement of housing prices and comparisons.”

“While housing might appear more expensive here than in the States, the problem is that many people use inappropriate comparisons.”

While Christopher says comparing a city like Melbourne to a rural area in the US is inappropriate, comparing prices to Chicago or New York reveals prices in Australia aren’t that excessive.

“Disposable income is the big factor here. We can’t just look at gross income, as that’s potentially misleading, so disposable income after tax is what’s important. This is because tax cuts over the past ten years have increased disposable income as a nation.”


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