New report puts Sydney and Melbourne among world’s most unaffordable property markets but experts question methodology

A new report has put Melbourne and Sydney at the bottom of a survey of the world’s most affordable property markets based on a ratio of median house prices to income levels, but experts say this method is faulty and doesn’t take into account factors such as interest rates and tax policy.

The report also comes as a new piece of research from Fitch Ratings also shows Australian banks would be able to withstand a doomsday-scenario where house prices fall by 40% and defaults skyrocket.

The Demographia International Housing Affordability Survey, which ranks 325 separate property markets, classes Melbourne as the 321st most affordable city. Sydney is classed as the second least affordable city.

The cities were ranked according by dividing median house prices in each city by average household incomes in each city. The formula suggests that Melbourne has a income-to-price ratio of 9x – that is, houses costs nine times average household income. Sydney is even worse, with a ratio of 9.6x. 

Saginaw in the American state of Michigan is classed as the most affordable, with a median multiple of 1.6 and a median house price of $61,400.

“The escalation of house prices has been financially damaging to households,” the report argues.

“Virtually all of the major markets in Australia, the United Kingdom and New Zealand and some in the United States and Canada, now have seriously unaffordable or severely unaffordable housing. In many of these markets, house prices have doubled or tripled relative to incomes.”

Various other Australian cities including Toowoomba, Canberra, Shepparton and the Sunshine and Gold coasts have also been named on the list.

“Australia’s burgeoning house prices have forced many households into both housing and mortgage stress,” the report says.

“Last year’s Demographia International Housing Affordability Survey showed that the median income household would spend between 57% of its pre-tax gross income for a mortgage on the median priced house in severely unaffordable Sydney and 50 percent in Melbourne.”

But some local experts say the report isn’t accurate. Paul Braddick, head of property and financial system research at ANZ, says using the ratio of house prices to income doesn’t present an accurate picture of the market overall.

“This is the main point we’ve tried to make in early notes. Using single metrics like that to make comments about the value of house prices is unwise because it ignores so many factors that play on house prices.”

“The obvious one is interest rates, but there are a whole range of factors to consider including different taxation policies, the number of investors, the quality of concentration in some urban centres – all of these come into play.”

Braddick’s comments come just days after ANZ published a report arguing the various metrics used to judge housing prices are inaccurate because they only provide a snapshot. Braddick says while the survey is interesting, it is not how ANZ judges affordability.

“Generally, we use a lot of individual metrics. So some of the simple ones like rental yields and house price to rent ratios can be used, but different taxation rates play a huge part in this as well.”

“Much of the argument that also pins up the house price to income ratio is that people argue that ratio needs to return to an historical average. But that reversion is quite questionable in the context that interest rates have fallen quite significantly. There’s really no justification for reverting to that previous metric.”

Rismark managing director Christopher Joye has been particularly outspoken regarding the house price to income ratio, and has argued that housing prices are not out of reach for the average buyer.

According to the company, the ratio of price to disposable household income ratio has dropped from 4.6 to 4.4 in the September quarter.

“On this basis, there appears to be little evidence that housing market valuations have become more stretched in recent years, as is commonly claimed,” Joye said in a blog post last month.

He also points out that Rismark’s calculations take into account dwellings across all regions, not just capital cities, property types, and the ABS quarterly national accounts measure of average disposable household income, not just household earnings.

“In the 12 months to September 2010, disposable incomes per Australian household rose by 6.8% while the cost of the median dwelling across all Australian regions increased by 6.6%.”

“Australian disposable household incomes have also out-run median dwelling prices over the preceding three years with compound annual growth rates of 5.0% and 4.2%, respectively.”

Meanwhile, a new report from Fitch shows that if housing prices were to fall by 40%, the local banks would be able to withstand such a catastrophe.

“Even in a severe downturn, gross losses incurred by the four major banks in their mortgage portfolios would be manageable,” John Miles, senior director at Fitch Ratings, said in the report.

“Of more concern would (be) the broader state of the economy, should such a downturn ever occur, and the impact this would have on commercial loans.”

Losses for the banks after insurance protections would range from $US100 million to $US2 billion under the scenarios, with insurers’ losses to reach a maximum of 56% in the third year of such a downturn.

However, Miles says vulnerabilities for the housing market include a relatively high household income to debt ratio, and the sector’s reliance on wholesale funding.