While house prices have risen sharply in some Australian capitals, namely Sydney and Melbourne, it’s still being debated whether the price surges are indicative of a bubble that’s headed for a major correction.
Although there will be much more debate, it is clear that affordability in many areas has decreased.
JP Morgan recently examined the issue by analysing a variety of valuation metrics to show how expensive house prices have become compared to what they’ve been in the past.
The bank’s price-to-income (PTI) ratio for Australian capitals, which analyses the median price for a property compared to median household incomes, shows that the PTI ratios for Sydney and Melbourne have grown rapidly in recent years, diverging from the levels seen in other capitals.
Sydney’s PTI ratio is now 9.5 times income, up 39% over the past five years. Melbourne has experienced a 30% increase in PTI over the same period, at 8.7x income. The PTIs for capitals have remained relatively stable, except that of Perth and Darwin, which have experienced a decline.
Henry St John, analyst at JP Morgan, said the Australian PTIs give “cause for concern” when examined through historical standards and relative to other countries.
“If house prices deviate persistently above residents’ ability to pay for them, it suggests a speculative rationale for buying a property,” he said.
The price-to-market ratio, or the house price minus the annual rental cost in many capitals is increasing. This means that rents are rising faster then prices.
The greatest gains in PTR ratio have been seen in Sydney and Melbourne, which is not surprising.
“As the RBA has eased [rates] steadily since 2011, ongoing price inflation and the relaxation of rules around sales of new property to foreign buyers helped incentivise a surge in residential investment in Brisbane, Sydney, and Melbourne,” St John said.
“The glut of new supply is weighing on both prices and rents in Brisbane, as the city’s stable PTR attests. Meanwhile, strong population growth, perceived market stability, and stronger foreign buyer interest allowed Sydney and Melbourne price inflation to outpace sluggish rental rates consistently.”
It is clear that housing in some capitals is more costly than it was in the past. However, does this mean that prices are going to continue rising?
St John explained how analysts cannot predict whether there will be a bubble or not, but PTI/PTR can be combined together with real price rise to forecast a 15% drop over the next five-year.
Based on JP Morgan’s modelling, the city most at risk of a significant price decline is Melbourne, followed by Sydney,
“Sydney and Melbourne exhibit significantly higher likelihoods of correction than the other capital city markets, at 18% and 19%, respectively,” St John said. “In Sydney, the core drivers of this estimate relate to the significant acceleration in real price and PTI growth over the last five years.”