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Are Australian homes overvalued?

John McGrath
15 March 2011

The Economist magazine published an article this month claiming that Australian house prices are the most overvalued in the world. Based on their calculations of the ratio of house prices to rents developed for overseas markets, our houses are a questionable 56 per cent overvalued.

The Economist article explains it this way: “In theory, the price of a home should reflect the value of the services it provides. People who choose to rent their homes buy those services on a monthly basis. Home prices should therefore reflect the rents that tenants pay.”

In my opinion, comparing house prices to weekly rents is not a good way of measuring whether our real estate market is overvalued.  When you own a home, you have a place to live and a significant financial asset. When you rent a home, you simply have a place to live. Annual rents only represent about five to six per cent of a property’s worth and the costs of owning a home or renting are both impacted by supply and demand.

There’s a difference between being overvalued and valuable. Australians place a high degree of importance on home ownership so it’s hardly surprising that we’re willing to pay well for an asset we consider extremely valuable both for our financial security and for our day-to-day lifestyles.

Given we’re undersupplied nationally by about 200,000 homes, yet we have very strong population growth and one of the best economies in the world, we have to compete for the homes we want and that’s what drives up prices. This doesn’t mean we’re overvalued – remember, property is only worth what the market is willing to pay.

Let’s compare our property prices to the rest of the world. Last year, the $52 million sale of ‘Villa Veneto’ on Wolsely Road, Point Piper created a new Sydney record on what is considered one the world’s top 10 most expensive streets, according to the Dow Jones Financial News index.

At around $38,000 per square metre (sqm), this is actually half what you would pay on the world’s other most expensive streets, such as Severn Road on Victoria Peak in Hong Kong ($AU73,200 per sqm), Kensington Palace Gardens in London or Fifth Avenue in New York (both $AU68,000 per sqm).

The Economist also expressed concern that Australian property prices rose almost 20 per cent in the year to the first quarter of 2010. That sort of growth was not surprising to me as we were coming out of the GFC during which time house prices corrected by 10 to 20 per cent. I don’t think the market’s rapid GFC recovery means we’re now overvalued – I think it shows Australians’ confidence in property as a highly valuable asset.

Australians are extremely savvy about home ownership because it is essentially part of our culture and a dream that most people aspire to achieve. The bulk of us can’t get there without borrowing to buy and every now and then the ‘bubble’ theories start doing the rounds of the real estate market. So let’s look at this.

In addition to the strong fundamentals supporting our real estate market (the undersupply, rising population, strong economy), we also have a pretty responsible bunch of homeowners in this country.

We have a very small rate of loan defaults, the RBA says most Australians are currently paying higher loan repayments than necessary and we have a rising number of people choosing fixed rate loans for security now that interest rates are returning to normal levels.

Australian property is not overvalued and Australian homeowners aren’t irresponsible with debt. I think we’re very well placed to achieve strong growth in property prices in 2011 and I’m looking forward to it.

We often talk about the difficulties buyers face in affording a home but it’s important to remember that 70 per cent of Australians own their own home and rising property values directly benefit their financial futures.

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