RBA wags the dog on housing affordability

Today, the AFR has run an article by Christopher Joye, director of Rismark, a private company that sells property price indicies, that draws upon a recent speech by the Reserve Bank of Australia (RBA) governor, Glenn Stevens, which argues that Australian housing is not expensive by global standards:

In an unusually sparkling sermon, entitled The Lucky Country, Governor Stevens presented important new research comparing Australia’s “dwelling price-to-income ratio”, which is a common valuation benchmark, to a range of peer countries…

The first take-away from the Governor’s speech was that the price-to-income ratio is currently sitting at around four times…

I’ve also suggested, but never empirically proven, that these levels do not appear unseemly by international standards, while highlighting the difficulties of comparing price-to-income ratios across countries due to differences in data reporting methods and tax regimes…

After tipping his hat to these constraints, the Governor ploughed ahead to formally address this gap. He pulls off the daunting research feat of compiling price-to-income ratios for an array of nations, including Ireland, New Zealand, the UK, Canada, Germany, the US, Japan, France, Italy, the Netherlands and Belgium, all the way back to the early 1980s. Reflecting on this work, the Governor opines:

“To the extent that we can make any meaningful statements about international relativities, the main conclusion would be that Australian dwelling prices, relative to income, are in the pack of comparable countries. In this comparison, the United States seems the outlier.”

Unfortunately for the RBA, their calculated ratio of dwelling prices to disposable income for Australia (4.0 times nationally) does not stand-up to scrutiny.

According to Rismark, the average home price nationally was $447,994 as at June 2010. Given that dwelling prices nationally are down around -6% since peak, we can estimate that the average dwelling price nationally is around $421,114 currently, which suggests that average household disposable income (i.e. after taxes) is around $105,000 according to the RBA’s ratio calculation. This is a ridiculous notion given:

The ABS 2009-10 Household Income and Income Distribution Survey showed that the average after-tax household disposable income was only $74,360.
The 2009 Household, Income and Labour Dynamics (HILDA) Survey estimated that an Australian household only needed to earn over $77,500 after-tax to be classified in the top two income quintiles (i.e. the top 40 per cent of income earners);
Individual average annual earnings (pre-tax) were only $54,600 as at March 2012;
The ATO Taxation Statistics showed that individual average (pre-tax) taxable income was only $66,500 in the 2009-10 financial year; and
The 2011 Census revealed that median annual household income was only $64,168.

Whichever way the data is cut, the RBA’s suggestion that average household income is around $105,000 is very inflated, which throws its whole comparison of Australian dwelling prices-to-income into doubt.

Indeed, only recently RP Data published research confirming that the RBA’s ratio is significantly understated. Using household income figures derived from the 2011 Census, RP Data estimated that the national median capital city dwelling price to median household income was 6.3 times in 2011 (see below table).

Moreover, the calculations used in Glenn Stevens’ speech directly contradicts those of the RBA’s then Head of Research, Anthony Richards, who in 2008 provided the below chart showing “Australia’s median house price to income ratio [to be] quite high by international standards”. Note that the ratios shown for the other nations are also prior to the global house price crash.

Back to the AFR article:

Stevens then points out that on his measures, housing affordability has not been better in over a decade. Indeed, he cheekily queries whether the alleged “affordability crisis” that has been promulgated by the popular media might morph into a purchasing power problem:

“Scaled to measures of income, Australian dwelling prices on a national basis have in fact declined and are now about where they were in 2002. That is, housing has become more ‘affordable’. Four or five years ago we supposedly had a housing affordability ‘crisis’. Now it seems that the problem some people fear is that of housing becoming even more affordable.”

It is interesting that Mr Joye should bring up this point. In his Lucky Country speech, Mr Stevens produced the below chart to argue that housing affordability is the best that it has been for a decade:

As a result of lower house prices and therefore lower loan sizes, somewhat lower interest rates and a good deal of income growth, the repayment on a new loan on a median-priced house as a share of average income is now at its lowest for a decade (except for the ‘emergency’ interest rate period in 2009).

Yet, the RBA’s claim is contradicted by its own data, which shows the share of aggregate (economy-wide) household disposable income eaten-up by mortgage interest payments (let alone extra principal payments from higher prices) is nearly double that of a decade ago:

Similarly, the 2011 Census results revealed that the share of median household income devoted to mortgage repayments has increased significantly, from 25.6% in 2001 to 33.7% in 2011 (see below chart):

Clearly, the RBA Governor’s claims about Australian housing affordability do not stand-up to scrutiny. Although affordability is indeed improving, thanks to reduced dwelling prices and lower mortgage interest rates, Australian housing remains expensive.

Twitter: Leith van Onselen. Leith is the Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.