The chart that proves property prices are undervalued

GUEST OBSERVATION

Saul Eslake, chief economist at Bank of America’s Merrill Lynch financial services division, released a chart last week that confirms the median house price in Australia is below implied price based on income growth and interest rates.

In Chris Pash’ article published in Business Insider last week, Eslake is quoted as saying that “house prices will converge with ‘fair value’ estimates based on household income growth and mortgage rates” after an anticipated 3.5-4% increase in 2015, if there is no change in interest rates.

Eslake sees possible deceleration in growth of nominal prices, or even a decline in real prices, in 2016 as the Reserve Bank of Australia starts to raise interest rates.

Eslake’s finding that property prices are below fair value confirms conclusions from my own research I have been sharing with Property Observer readers since last year:

• Australian property prices explained: Independent analyst
• Australian property prices in 2014 and beyond - a peek into the future
• Crisis of confidence or crisis of affordability? 

Saul Eslake is better known to the property industry observers as an avid critic of negative gearing on property and a frequent commentator on housing affordability issues.

Therefore I have nothing but praise for Saul that he was prepared to publish a piece of research that contradicts his previous, very strong stance, on these issues.

As John Maynard Keynes said: “When my information changes, I alter my conclusions. What do you do, sir?”

Since I have not seen this chart before, I can only assume it is just the latest revelation from the research that Eslake and his team at Merrill Lynch undertook recently.

I can only hope that Merrill Lynch will be prepared to fund further investigations into specific nuances of the Australian property market - for the benefit of their clients but also, as a by-product of their PR, to keep the Australian public informed with key findings.

I have no doubt that this research will only confirm that property prices in Australia are primarily driven by changes in incomes and interest rates, that affordability is not an issue for working Australians (i.e. as in most developed countries, is only an issue for specific underprivileged groups), that there is no bubble in the property market and that prices are well within expected range. And, of course, that negative gearing plays only a minor role, if at all, in the whole scheme of things.

In essence, all these are already proven by the above chart, but additional research would broaden the evidence.

Oh, and one more comment to finish off – it demonstrates that price-to-income measures, favourite with many economists, property commentators and some publications that purport to be a serious economic research, are grossly out of touch with the reality. But this fact is already well known to Property Observer readers from my previous articles.

I am looking forward to more research revelations from Saul Eslake and Merrill Lynch team. Thanks a lot for this first little gem!

It is a most welcome development and I sincerely hope that propagation of this and similar information in the public domain will bring balance to the debate on the state of the property market in Australia.

Arek Drozda is an independent property market analyst.