Joe Hockey says bubble talk is "lazy", but is he right?

GUEST OBSERVATION

Federal Treasurer Joe Hockey has dismissed the idea that a property bubble is forming in Australia, citing the lack of supply as a primary reason for our high domestic prices.

This is an analysis that we, Propell National Valuers, agree with, as set out in an article we published last month.

The statement follows statistics published by the Bank of International Settlements (BIS) and The Economist showing that, as measured against income and rents, Australia had one of the highest relative price levels in the world (Only Belgium had higher prices.)

Joe Hockey called their surveys “lazy analysis”. We would agree that the reports are based on “rules of thumb” that are interesting but only have limited application. The same surveys showed Chinese prices as some of the cheapest in the world, but no-one is expecting Chinese prices to increase.

Anyone who wants to argue that Australia is in a housing bubble should also argue that Chinese real estate is at bargain prices, and no-one believes the latter to be the case.

BIS quoted Australia as having the largest price increase in the past year:

“Year-on-year residential property prices, deflated by CPI, rose by 9.5% in the United States and 6% in the United Kingdom. Real house prices also grew, by 7% in Canada, 7.7% in Australia and 2.2% in Switzerland, three countries that were less affected by the crisis, as well as in some countries that were severely affected by the crisis, such as Ireland (+7.2%) and Iceland (+6.4%).”

The BIS statement matches a recent article in The Economist (30 August 2014 edition):

“Australia has one of the most over priced housing markets in the world.”

However, this is based on a couple of simplistic measures, being price versus rents, and price versus income.

Measured against rents, they assert that Australia as a whole is 55% over valued, the only markets exceeding this being New Zealand, Canada, Belgium and Hong Kong.

Measured against income, they assert that Australia is 33% over valued, the highest figure in the world.

Given the disparity of price growth in our cities, this implies that Sydney and Melbourne are way overvalued, while the other capital cities are a little above fair value.

But is this an accurate way to measure under/over valuation?

Against income, The Economist says that Australia is 33% overvalued. But at the other end of the scale, they also say that China is 38% undervalued.

If we accept the logic that Australian prices are too high, then we would also accept that Chinese prices are too low. Yet the consensus opinion is that the Chinese market is oversupplied and that prices could fall.

Even Chinese buyers are conspicuous in buying Sydney real estate, indicating that they see better value in Australia than in China.

In a blog article last month we highlighted the major driver of prices: supply v demand. Joe Hockey is right to draw attention to the supply/demand equation in justifying the present level of house prices.

China may well be undervalued by comparison with incomes, but another factor is at work. The market is considerably oversupplied, with plenty of reports highlighting the amount of constructed yet empty apartment space in and around the major cities. So the excess of supply over demand has kept prices lower by comparison with incomes.

In Australia, we have the opposite equation: supply has not kept up with demand, and excess demand is driving prices up. To the extent that demand is supporting prices, there is a good argument to say that our prices are not too high.

Rising prices should be a signal to increase supply. Indeed, levels of new home construction are improving, but not at the pace that would reduce prices. Supply is relatively inelastic, with impediments to new supply including lack of available land (where it is wanted) and planning limitations.

This can easily explain why Sydney prices have been increasing at the fastest pace. Simplistically, the demand is for inner city housing, while supply is most elastic on the metro fringes. The lack of sufficient supply in Australia is a result of inelastic availability of land, plus, what land there is, tends to be at the fringe of cities, whereas demand is for residences closer to the CBD. Inner city suburbs are encouraged to increase residential densities but this often comes up against the NIMBY factor, existing owners oppose higher density developments in their neighbourhood.

On the demand side, our high level of immigration has the effect of increasing demand which cannot easily be satisfied. Immigration policy appears to be set without reference to the domestic ability to cater for their housing needs, but policies are unlikely to change in the short term.

So Australia remains in a position of having insufficient supply of residences. Prices may be high relative to rents, but at present interest rate levels the market continues to be supported by buyers and there is no suggestion of it being overpriced. If interest rates rise, then that would change the equation, but we are not there yet.

Linda Phillips is national research manager with Propell National Valuers.