Australian houses are not overvalued, prices should rise over next 12-18 months: ANZ

A new report from ANZ claims residential properties aren’t overvalued and has taken aim at traditional methods of evaluating affordability, including price-to-income ratios, saying they don’t take into account more complicated and less-quantifiable factors including historic declines in interest rates.

Senior economist Ange Montalti also says the current short-term trends affecting housing prices, including a decline in demand and the lack of first-home buyer stimulus, won’t last for more than a year, predicting stronger growth in 2011-12.

“We’ve had a few rate rises, but these are temporary reactions, we believe, and are not significant in the long-term. Our view is that with the housing market being quite tight, we should see some support for prices over the next 12-18 months.”

Montalti says the new report was written in order to bring into consideration pricing factors that are not recognised, including those that are less quantifiable such as deregulation which has caused credit to become more widely available.

“So what happens is that people tend to look at main pricing measures including house to income ratios to determine the affordability of the market. But those are only okay as a starting point and don’t take into account bigger movements over long periods of time.”

“In the late 1980s you had very high mortgage payments, which meant for any given dollar of debt you had to pay 15 cents in the dollar. Any dollar in debt today only costs you seven cents – you can sustain double the debt levels for the same burden.”

The ANZ report lists a number of measuring ratios including the actual price level, house price to income ratio, debt-servicing ratio and purchasing affordability.

But these are all flawed in providing a sense of the how the market overall is holding up, Montalti argues. For example, the house price to income ratio mode is listed as “ignoring shifts in cost of funding, other structuring shifts, housing market conditions and credit availability”.

The debt-servicing ratio is, “Okay as a guide…[but] little direct insight offered to house price analysis”. The purchasing affordability ratio, which is listed as the “interaction of interest rates, incomes and house prices”, is labelled as “useful for typical first-time buyers” but otherwise takes no account of affordability for investors and upgraders.

More importantly, Montalti says, is how the market is performing now and where those prices are actually moving. He points out the country has quite a low delinquency rate, which is evidence of a largely affordable market that is valued correctly.

“Critically, the persistence of very low housing loan delinquency rates over several decades (including through the most recent GFC) is the greatest testament to the sustainability of debt levels and house prices in Australia,” the report points out.

“That lenders continue to adhere to tough eligibility criteria minimises the probability that any event shock will emanate from ‘over-provision’ of credit.”

Montalti says buyers need to look at the “bigger picture” when it comes to house prices.

“That ability to service the mortgage is critical to this whole discussion, and that on its own explains a big chunk of where prices are at the moment.”

“For instance, if you only considered income, then prices would need to fall 48%. That’s a big number, but if you consider income, along with the decline in interest rates over the past 20 years, then prices only need to fall about 13%. The same interest rates are what determines serviceability.”

Then, he says, that remaining 13% can be attributed to financial regulation and less-quantifiable examples including changes in tax conditions and “the overall impact of deregulation which moves from a system of rationed credit… to one that uses debt facilities to use credit”

Montalti says the question of affordability is not irrelevant, but at the same time, “is not an easy one to answer”.

“What you have to look at is whether or not conditions are going to change moving forward that stabilise the market or use the opposite effect. We use these measures of tools.”

So what’s going to happen in the future? Montalti says the current low level of delinquencies right now means affordability is on track, but warns that “a substantial increase” in interest rates over a short period of time could threaten to destabilise the market.

“But having said that, that’s not something the Reserve Bank is going to do without giving a considerable amount of thought to, and it’s not on the cards. There would need to be certain circumstances which require that.”

“There are always swings and roundabouts in the housing market, with regard to interest rates. But it would take a substantial swing upwards to disrupt the market.”

Looking forward, Montalti believes a shortage of properties in certain areas, based on the population growth models, will keep prices moving in the second half of 2011, moving on into 2012.

“Worst case scenario is that we get some more flatness for a bit longer. But we have pent up demand, and there aren’t enough homes, so we suspect there will be upward movements in prices going into 2012 and 2013.”

The report also points out that in a risk scenario based around a major collapse in the terms of trade, could likely prompt policy settings “that can only be favourable for house prices, particularly if house price momentum has been restrained”.

“Policy-makers intent on preparing for a ‘post-terms of trade collapse’ environment are likely to shift settings to a more accommodating stance. While the economy is likely to slow, the interest rate-sensitive sectors such as housing will benefit considerably and swiftly.”