Does Australia have a house price bubble?

A bubble about to pop

According to this article from the Economist, Australian house prices are 50% overvalued. I’m normally sceptical of worldwide measures like that, but in this case, the Economist looked at the long term residential rental yield in each market, and then compared it with the current rental yield. So for my own house, my best estimate is that the rental yield is 3% at the moment – my gross income on the house per annum is 3% of what I would get if I sold it. And given that I can get 5.6% interest on my savings at the moment, housing (or at least my house) doesn’t look like a great investment, unless you think that prices are going to substantially increase over the next few years.

I was quoting that measure to a colleague this week, and he commented that the only way to truly measure supply and demand in a housing market is by looking at rental vacancy rates. If you have crazy demand for houses to purchase, then that is just everyone piling in because they are scared they will miss the boat. But if would-be renters are having to bid over the market rent for properties (which has happened in parts of Sydney in the past, but certainly isn’t true now) then you know there is a problem with housing supply.

Six or seven years ago, I made the economically rational decision to rent rather than buy a house. The market was overpriced, in my view, and the transaction costs for Sydney real estate are about 5% of the purchase price. While there are some tax benefits to investing in your own house (capital gains aren’t taxed) they aren’t all that significant compared with the financial costs if you have any suspicions at all about the directions of prices. But I found that the rental market and the ownership market are two different markets. There are vast areas of the Sydney real estate market with very few rental properties. That includes a substantial proportion of the house (rather than apartment) market. So in the end, the only houses we could find that we liked were for sale, rather than for rent.

That tends to mean that rental yield measures aren’t all that good as a measure of a market. So I’m not sure if I believe the Economist. But I think I’m inclined to be a renter rather than an owner, at the moment (if I didn’t have transaction costs to get there).

And one more piece of evidence – Australia’s home prices have risen more than pretty much any other country since 1987, according to this fun chart, again from the Economist.