The RBA today published a discussion paper entitled Is Housing Overvalued?
This is an important question, given The Economist (2013) and the OECD (2013) report that Australian house prices are 24 per cent and 21 per cent ‘overvalued’, respectively. The report makes the point cost to income ratios are meaningless unless you know the cost of the alternative!
Their approach is to examine whether it is more expensive to own a house or to rent. They assess houses as ‘overvalued’ if home buyers pay too much, in the sense that they would be better off renting than buying. This involves comparing the financial cost of renting a home with the cost of owning a similar dwelling, where the latter depends on the purchase price, interest rates, repairs, council rates and so on.
They conclude that real house prices have increased at an average annual rate of slightly less than 2½ per cent since 1955. If this rate of appreciation is expected to continue then houses are fairly valued. Many observers have suggested that future house price growth is likely to be somewhat less than this historic average. In that case, at current prices, rents, interest rates and so on, the average household is probably financially better off renting than buying.
Interestingly, there is no direct discussion in the paper on housing bubbles, though there is a throw away line in the abstract “Recent data do not show signs of a bubble”.
Now, we agree that there is not a housing bubble in Australia, rather thanks to macroeconomic policies over a long period, poor land release, and freely available credit, house prices are out of kilter, based on loan to income, loan to value, and on other metrics. In fact, the best approach is to use a range of measures to baseline the position of house prices, across countries. The weakness in the RBA analysis is that house prices and rental costs are connected, so they will tend to move together. Therefore, relatively speaking the fact that rents are tracking prices are not a good indicator of whether house prices are over valued. It is a closed system, and self fulfilling.
