Can capital city house prices go much higher?

This headline could equally have been “How much crazier can things get?”

It was prompted for me by a recent conversation with a long standing real estate agent friend, who (perhaps overly enthused at the prospect of Olympic real estate gold for Brisbane) suggested to me that house prices could easily double in Brisbane in ten years.

I was shocked at the idea.

“How could that possibly happen?” I asked him.

Here’s why I was sceptical, and it applies to every capital city market in the country.

For starters, Brisbane’s median house price is now $1 million.

It’s roughly the same for the other major capitals while Sydney’s is closer to $1.5 million. The median household income around the country, however, is only around $100,000 per annum.

That’s how we get a price to income ratio of around 10 times (closer to 15 for Sydney). Here’s how that looks over time for the five largest capitals, according to the annual Demographia global study of house prices:

My friend who thinks prices could double was looking at this only through his real estate lens.

Look at this from an income and debt servicing lens instead.

If prices were to double, to say $2 million for Brisbane, what’s the outlook for incomes? Will they also double? No is the short answer, or if they did we would be in some sort of dystopian economic nightmare.

Looking at income growth over past years, and given the focus on wage restraint, it’s being generous to suggest income growth of 3.5 per cent per annum compound for the next 10 years.

That will take our current median household income of $100,000 to $141,000 in ten years’ time, which, relative to a median house price of $2 million by then, is a multiple of 14 times incomes. And Sydney, which is already nearing 15 times, will be more than 20 times incomes.

If you believe this can happen, you will also be saying that Australia’s capital city houses will be some of the most expensive in the entire world. For some global comparisons, Singapore is currently 4.2 times incomes, Houston (US) is 4.3, Greater London is 9.1, Boston (US) is 6.7, Toronto (Canada) is 8.4, San Francisco (US) is 10, and Hong Kong is 14.4.  

I understand that some dislike the median multiple measure, arguing that mortgage costs and other tax related issues vary from country to country – which is true. But as a global benchmark, it is hard to argue against.

Others will argue that the outlook for falling interest rates will take pressure off housing in Australia. Not likely. In analysis I have done for the Property Council in various states over the last year, even if interest rates fell by 1.5 per cent (or 150 basis points) and incomes rose by 50 per cent in the very short term, and house prices stayed the same, we would still have an epic affordability crisis.

The reality of course – which we are already seeing – is that falls in interest rates quickly flow into rising prices, instantly eroding any benefit to the purchaser.

Are soaring prices sustainable?

To keep some perspective around what an affordable housing market might look like, let’s assume we get some rebalancing such that in ten years’ time our future household income is $141,000.

If prices were six times incomes (still unaffordable on global measures) that would leave house prices at $846,000. So in ten years’ time, house prices will need to be less than they are now and incomes will need to be 40 per cent higher. What are the chances of that?

Are we stuck with this as a slowly unfolding housing train wreck, without an end in sight?

Some relief might be possible if we could deliver new supply into the market without slugging it so viciously with punitive tax and regulatory measures.

Research earlier this year by CIE for the Housing Industry Association revealed that statutory taxes, regulatory compliance costs and infrastructure charges now account for 40 per cent or more of the cost of a new typical house.

That explains why a new house and land package costs around $800,000 to $1.25million in many major cities – when more than $350,000 (up to $576,000 in Sydney) is government imposed costs.

Should we hold our breath for governments around the country to massively cut housing taxes to stimulate supply and reduce costs? Hmmm.

Maybe instead we could hold out hope that the paperwork that’s entangled new supply will be relieved of needless process and irrelevant compliance?

In some fascinating research in Inflection Points this year, it was revealed that the number of planners per each new home built has increased seven fold over the last 30 years, while actual construction industry workers per dwelling have doubled.

The scale of reform needed to give us back a once ‘fit for purpose’ regulatory framework is unlikely to happen in my view. We love our red tape.

So back to my friend and his overenthusiastic prediction that house prices will double inside a decade. Is he right?

I’d be very worried if he is. All that will mean is that rising prices generate more equity for those already in the market, which will be leveraged to buy more ever costly real estate, leading to yet more concentration of wealth. The top 10 per cent of households already own nearly half of all wealth in Australia, while the bottom 60 per cent own just 17 per cent.

If that worsens, which it almost certainly will if my friend is right, you will be watching large scale left wing street protests and the rise of political parties calling for wealth redistribution – death duties, taxes on large superannuation balances, rent controls, changes to capital gains taxes and negative gearing …

Oh, wait! Are we already there?