The Economist on Australian Housing

Some readers might have seen it already, but the Economist has just released an article questioning the sustainability of Australia’s house price boom. Here are some key extracts (article available here):

This week in The Economist we will publish our quarterly index of house prices around the world. Australia’s homes are the most overvalued in the index. The ratio of prices to rents in the country is fully 56% above its long-run average (see chart)…

Many economists in Australia argue that the country’s lofty property prices are justified by a variety of fundamentals. Immigration has swelled the population, and zoning regulations, infrastructure charges and the like have imposed artificial constraints on the availability of land…

These fundamentals no doubt matter. But one of the virtues of a price-to-rent ratio is that it takes them into account. If immigration is putting upward pressure on house prices, it should put upward pressure on rents too. And if developers can’t build homes, they can’t build rental homes either. Those factors may justify high prices. They don’t justify high price-to-rent ratios…

If things are different now, why might that be? Low interest rates and financial liberalisation is one answer. But Ireland, Britain and America enjoyed those too. What marks Australia out of course is its extraordinary resource boom. The country’s terms of trade (the price it can fetch for its exports, relative to the price it pays for its imports) is at its highest since the 1950s (see chart). So perhaps lucrative exports of iron and coal justify rich valuations for bricks and mortar?

It’s hard to deny that Australia’s house price boom has been fuelled by a number of factors, including:  a massive increase in household leverage funded through the banks’ heavy offshore borrowings; rising incomes courtesy of the China-led commodities boom; and Baby Boomer demographics. Add unresponsive supply into the mix, and much of this extra demand has manifested itself in higher prices rather than new construction.

The question then is whether the extra housing demand is permanent or temporary. Clearly, households appear to be reaching the point of debt saturation and are starting to deleverage, as evidenced by increased home equity injection, higher household savings rates, and falling debt-to-disposable income. So we can expect little debt-fuelled house price growth going forward.

The Baby Boomers, whose mass buying of investment properties in the mid-1990s and 2000s was a key demand-driver of house prices, are starting to retire. So we can expect little support from this cohort going forward.  

This leaves the China-led commodities boom as the key support for house prices. But with commodities prices already at near 100-year highs, how realistic is it to expect them to stay elevated indefinitely?

When you get down to it, Australia’s ability to benefit from the China growth story is the key factor separating our economy and housing market from those of the United States, the United Kingdom, Spain, and Ireland, amongst others.

But should China’s economy slow significantly, we might experience the same fate. Then we will wish that we had the foresight to establish a sovereign wealth fund that saved some of the bounty for a rainy day.

Cheers Leith

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Unconventional Economist
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  1. Leith – two things struck me with that Economist article.

    First, the high correlation between terms of trade and the price-to-rent ratio.

    Second, the clear fact that there is a huge separation between all other metrics used to measure housing values and the simple price-to-rent ratio.

    I’m currently renting a new house that costs less than half to rent then if I were to buy the house with a 20% deposit at 7.5% interest. This story is repeated across the nation. My partner – Q Continuum – rents an apartment close to the Brisbane CBD at less than half the mortgage cost.

    I believe rental increases have broadly followed the CPI – unlike house prices which have been double the CPI for over a decade.

    • Agreed Prince. It’s the same story across most of Australia. Sydney’s rents are the only city that have risen well above CPI. But even there, renting is still way cheaper than buying.

    • Good point Prince regarding it not just being the rent/price ratio that’s out of whack. Pretty much any measurement you throw at property such as income/price, total land values/gdp, housing vs price of other assets is showing that housing is way overpriced.

      I rent in a beachside suburb in Adelaide for half what it would cost to buy also.

      Provides cashflow for other investments and the landlord takes the price risk on any correction we experience. Works for me!



      • Agree with the above. It absolutely boggles the mind how anybody could look at the ratios and still say there is no housing bubble in Australia.

    • Sam Birmingham

      Great link, @Sceptic … Am listening to it right now; what a clearly-argued, statistically-backed wrap of the China situation!

      Thanks for the article, @Leith. I found myself nodding furiously to The Economist’s piece, although I still think they missed one thing… Yes, the tipping point for prices came in 2000, but I think that the other big driver was demand-stimulatory Government policies; specifically, adding FHOG to the mix, on top of negative gearing and CGT concessions that were already in place.

  2. Was out looking at land this morning in middle distance eastern Melbourne. Stopped in at an agent to chat. The news is that the new lending regulations are starting to bite. Pre approvals of finance where being revoked throughout December. The agent has observed sold properties reappearing on the market as finance falls through. She has had some of her own “solid deal” sales fall through over the last 2 months.

    People are complaining of now having their HECS debt added to their commitments (among other previously ignored things).

    She mentioned trouble in the mortgage insurance situation. Perhaps a superblog investigation in to premiums and conditions is in order.

  3. Same here with the rent vs buy situation. If people are going to leverage the hell out of house prices, I’m more than happy to continue renting and being subsidised by these “investors”. Currently in Aspendale, VIC renting for about 1/3 the cost of repayments!!

    People who own tend to look down on us renters, but if they only knew whats going on behind the scenes with their awesomely overpriced house rising in value in recent years, they wouldn’t be so smug! Its not that we couldn’t afford to buy, we’re just not that dumb. 🙂

    • dumbfoundlings

      True, investors, or rather speculators, and recent home buyers have been taken to the cleaners.
      Banks must be laughing hard at how the sheeple just keep on wandering into the banks’ paddock of massive interest rate repayments whilst trying to dodge the ‘land mines’ of variable rates and rimmed by an electic fence of exit fees. Not only that, our hapless debt-laden sheeple must also deal with rises in cost of living whilst avoiding the biggest ‘cow pat’ of all – negative equity.
      Talk about animal cruelty.
      Banks ate the economy and politicians looked on in dumbfoundment.

  4. For those that think Australia is over-priced, consider these facts about India. A small apartment in India’s metros costs about USD 250,000.00. Current mortgage rates are around 10%, so after 20% down, yearly mortgage payments will run about USD 20,000.00. The same apartment can be rented for USD 5000 per year, though. So why would anyone buy this apartment instead of renting? Simple…India’s corrupt society has figured out a win-win game for both owners and renters. Home prices have continued an absurd bubble appreciation percentage (over a thousand times in the past 30 years), so home owners benefit no matter at what price they buy. Renters benefit too as rents are far below mortgage costs. Yes, it is an absurd, non-zero-sum game, that only the crooked folks in India could have come up with and sustained for over 3 decades.

    Also consider these other facts
    – median annual income in these Indian metros is still below USD 5000.00
    – small individual houses (not apartments) cost USD 1 million or more

    • I should know better than to feed the troll but you can’t really be saying that Australian property isn’t a bubble because Indian property is more of a bubble can you?

    • It’s still a Ponzi scheme. Ponzi schemes are great until you find the last greater fool who doesn’t understand math, then it’s all over red rover.

      With a billion people in India, it’s not surprising there are still plenty of fools for a property ponzi. We only have 20-something million.

      But no matter what your population is, it ultimately always comes to an end. No matter how many words you put in your reasoning, you simply cannot fight math, nor the inevitable vertical asymptote.

    • Interesting – probably a result of Hinduism, most Indians have a fatalistic nature and rigid class structure. Peasants in India accept being peasants, corruption seems endemic and any semblence of will to challenge or even try change the status quo is weak.

      In regard to property, Aus is more of a nation of gamblers who will not think twice to break ranks. Many will take the windfall of the recent run-up in RE prices should govt fail to intervene if prices go appreciably south.

      Unfortunately for the socio-economy, successive govts have shown the ability to sabotage any stabilisation of housing prices – the last thing our ‘leaders’ want is affordable homes for average workers. I suspect downward jealousy is driving this mentality.

      Perhaps India and China are actually examples of our future.
      Sad if true and shame on our politicans for allowing it to happen.

  5. As usual great analysis Leith. Separates the wheat from the chaff and prioritises.

    Who’s yo daddy?

    No, not the ABC-Australian Banking Cartel-that’s a former carpetbagging sugar daddy!

    See that wizened old bent peasant(remember the one child policy) standing hunched over in the rice paddy with a rusty iron rice bowl?
    Thats yo daddy!!!