Australian house prices fell in eight capital cities by 1.7% in the March quarter – the largest drop since the financial crisis.

These numbers confirm the belief that Australia will experience a substantial price drop in the coming years. If you’re looking to buy or sell property, the rhetoric can be confusing.

Here are five factors that can create a housing boom.

1. Prices for houses

A sharp rise in house prices is an indicator of a bubble. In Australia, house prices in capital cities have basically doubled since 2003 (with the exception of Sydney house prices which increased from $573,000 to $671,000 – +17%).  In 2010, house prices reportedly “soared” 20% in the 12 months to March. However, NAB chief economist Alan Oster indicated at the beginning of 2011 that there’s been “a significant downward revision in house price expectation over the next 12 months”. ANZ said that prices will likely remain stagnant over the next year. According to RP Data/Rismark in March, the national median home value was $455,000 The Economist indicated in late 2010 that Australian house prices were overvalued by 63.2%, echoing an earlier study that found Australian property was “the most overvalued of any of the 20 countries we track”.

2. Affordability
A measure of affordability is the household income needed to afford a house. The Demographia International Housing Affordability Survey revealed Australian properties were “severely unaffordable” with a house price to household income ratio of 5.1 or above in the nation’s capital cities. There is some hope for homebuyers who are looking to buy. The affordability indicator of Commonwealth Bank/Housing Industry Association rose to 55.7 in the first quarter 2011 due to falling home prices. It was 54.1 in the last quarter of 2010. The report is based on the “long-standing premise that housing costs should not consume more than 30% of a household’s income”.

3. Rates of interest
For the fifth consecutive May, rates were set by the RBA at 4.75%. RBA governor Glenn Stevens noted in a statement that “new loan approvals for housing have moderated over recent months as interest rates have risen and the impact of large grants to first-home buyers has tailed off”. The RBA could lower the accelerator to reduce inflationary pressures, even though it has provided rate relief. St.George’s Monthly Economic Outlook for May indicated that the RBA is concerned a pick-up in mining investment could exert pressure on wages and other costs. “Recent RBA rhetoric has been more hawkish than previously with stronger references to inflationary pressures building,” it noted. “Importantly, the RBA expects underlying inflation to be towards the top of its 2-3% target by the end of this year, and to exceed 3% by 2013. It means there is little room for error on the inflation front for policy makers.” Further rate hikes could further soften the housing market.

4. Lending criteria
Australia has very high lending standards when compared to other countries. Lenders adopted stricter lending guidelines during the global financial crises. Lenders required 20% deposit at the height of the GFC, as well as proof of savings. Many lenders stopped offering non-conforming loans such as low-doc or no-doc loans. Lenders are now offering 95% LVR loans, and lending criteria have changed over the past 12 month. Lenders have more information about their borrowers thanks to credit reporting reforms. These lenders can then decline loans to borrowers who have poor repayment histories.

5. Delinquencies
Fitch Ratings reports that Australian defaults on home loans rose to their highest levels in the first quarter 2011. Rates of mortgages with more than 30 day late payments rose to 1.79%, compared to the previous three months’ 1.37%. Record low-doc loans with more than 30 days jumped to 6.74% from 5.7%. According to the rating agency, this is due to an increase in Christmas spending, an increased November rate, and recent natural disasters. Despite the recent uptick, mortgage arrears in Australia are still very low compared to other countries – delinquencies in the UK are around four times higher than Australia and in the US they are around 20 times higher.