Boutique fund manager Merlon Capital Partners has released a new paper Some Thoughts on Australian House Prices, arguing that although dwelling valuations in Australia are 5-15% above historical averages, the risk of catastrophic collapse in the housing market is low.
The paper looks at the house prices in Australia within a long-term context and within the context of the Australian tax system that favours owner occupied housing over all other asset classes.
Main insights from the paper include:
- The housing marketing is 5 – 15% overvalued relative to “mid-cycle” levels. However, this is unsurprising giving historically low interest rates.
- Regulations that have forced banks to ration lending are probably unnecessary and will achieve little other than improving short term bank profitability through higher interest rates for borrowers. In the long term, the RBA will take bank pricing decisions into account when setting official rates and unregulated lenders will emerge if market fundamentals remain sound.
- Given the sustained upward trend in price-to-income ratios since the 1960s and associated structural changes to the market, we don’t think it’s appropriate to compare current ratios to very long term averages. However, it is interesting to note that price-to-income ratios have fluctuated within a tighter band over the last 10-15 years.
- Dwelling rents are notably resilient to the economic cycle and have shown a remarkable tendency to grow above inflation over a long period of time.
- Although Sydney has experienced more rapid price inflation recently, this is arguably catch up following a period of underperformance between 2004 and 2010. The “Sydney premium” is currently broadly in line with historic averages.
- In fact, the tax and welfare system in Australia is enormously favourably to owner occupiers when compared to investors.
- As with all our investing, we work on the basis that, over time, interest rates will revert back to long term levels as will aggregate housing valuation metrics. Against this, we think aggregate rents and household incomes will continue to grow which will cushion the overall impact on dwelling prices and that the exposure of the household sector to higher interest rates means that the time frame over which interest rates will rise could be quite protracted.