The AFR’s Chris Joye has posted an excellent article this afternoon effectively debunking the RBA’s Dr Peter Tulip, who earlier this month ridiculously claimed that Australian housing was 30% undervalued.
In the article, Joye reviews new housing valuation analysis produced by Dr Craig Shepherd, an economist with the $10 billion fund manager, JCP. Consistent with Joye’s own views, Dr Shepard finds housing valuations are enormously sensitive to the RBA’s cash rate.
That is, if one irresponsibly assumes the cash rate never rises and remains at its current all-time low of 2%, national prices can be presumed to be “fairly valued”. However, even given this unrealistic scenario, the Sydney and Melbourne housing markets are still over-priced by 23% and 24% respectively, “even given the heroic assumption rates never rise”.
By comparison, if the RBA’s cash rate was to normalise to just 3.5%, Dr Shepherd’s research suggests Australian dwellings are currently 31% overvalued with Sydney and Melbourne home values 47% above fair value. “By any historic measure that would certainly be considered an asset price bubble,” he says.
Dr Shephard’s model “controls for mortgage rates, rental yields, maintenance, depreciation, building costs, inflation, and fixtures and fittings, among other variables, and then discounts back expected cash-flows to arrive at a valuation today”. He says that “with negative short-term ‘real’ interest rates in Australia [our cash rate is below our core inflation rate], and the Fed funds rate expected to rise over the next five years to about 3 per cent, it seems improbable the RBA can keep rates this low forever”.
In this context, Joye encourages readers to “reflect on Dornbusch’s Law, which advises that ‘crises take much longer time to come than you think, and then happen much faster than you thought'”.
Click here twice to read the full column or AFR subscribers can access the direct link here.
