Why house prices don’t need to be a consistent multiple of income

THEY’RE the figures people use to say we’re bound to have a housing crash. But do house prices really need to be a consistent multiple of income?

REAL ESTATE: 22 Young Street Albert Park Victoria. Bedrooms 4 Bathrooms 2 Car Spaces 2 House Auction: Sat 29-Aug-15 2:00PMSave to Calendar Picture: realestate.com.au

This graph keeps going up and it has everybody worried. But should we be?

Household disposable income, excluding income of unincorporated enterprises and before the deduction of interest payments. Sources: ABS; APM; CBA/HIA; RBA; REIA: RP Data-Rismark.

It makes sense house prices should be linked to income. But if the graph creeps up, does that mean there’s going to be a housing crash?

To answer the question, let’s go back 15 years. It’s the year 2000. John Howard is Prime Minister, Steve Waugh is captain of the cricket team, James Hird is a hero, and the median price for a house in Sydney is just $287,000.

At that time, the average annual fulltime wage was $43,000.

Let’s look at an imaginary household budget.

How an average wage could be spent in the year 2000.

The person earning $43,000 paid $9,300 in tax, leaving $33,700. Let’s imagine two-thirds of that (~$22,600) gets spent on expenses and a third ($~11,100) goes to the mortgage.

The standard variable rate in 2000 was 7.8 per cent so that budget is enough to pay the interest on a loan of around $143,000.

Let’s go forward in time again. It’s 2015. Nobody pays attention to cricket anymore, John Howard is retired and James Hird is a duffer. The median house price in Sydney is now just over $1 million.

Let’s check the budget of our average income earner again. Wage inflation has been pretty good in the last 15 years. Our average fulltime earner is now on $79,500. Wages have nearly doubled.

But what’s happened to the price of those living expenses? They’ve risen 53 per cent, according to the consumer price index.

If the mortgage-holder decides they will consume the same things they did back in the year 2000 that’s now going to cost $34,600.

That decision lets them commit a much bigger slice of their budget to their mortgage than before.

Instead of a quarter of their earnings, it’s now over a third. The fact wage inflation has been higher than goods inflation means they can pay a higher mortgage without changing their standard of living.

How an average wage could be spent in 2015.

The standard variable rate is now 5.45 per cent. That $27,500 a year is now enough to pay the interest on a loan of $505,000.

Australia’s standard of living has risen a lot in the last 15 years. So buying only the same things in 2015 as you bought in 2000 is not an easy option and not realistic. There are lots of ways in which society has shifted and constraining your purchases in this way would mean missing out.

But in some ways it is useful to consider. Mortgage holders — especially those in the early years of their mortgages — do scrimp and save. They do get by with less.

And it is in some of the most essential categories — like clothing — that price inflation has been weakest. The price of clothing rose just 1 per cent in the last 15 years, while the price of alcohol and tobacco rose 108 per cent.

Wage growth has been higher than consumer price growth across Australia’s history. That’s why we’ve had rising standards of living. It also means that some frugal people can scrape together large amounts to pay off big mortgages and that could be part of the reason house prices have blown up.

There are other reasons why people might be willing to borrow more money to spend on housing now.

• Macroeconomic stability — Australia is into its 25th year without a recession.

• More predictable and stable interest rates (the RBA controlling monetary policy);

• Longer lives;

• More flexible labour markets mean they are confident of finding another job if they lose theirs.

When you add in the fact female workforce participation has increased in the last 15 years and a lot more people are buying houses using two incomes, that means we can probably expect to see the ratio of house prices to incomes slope upward.

That’s not to say the housing market won’t crash. It easily could, especially in Sydney. I’m not saying it won’t. But the graph of dwelling prices to income is not proof on its own.

Jason Murphy is an economist. He publishes the blog Thomas The Think Engine. Follow him on Twitter @jasemurphy.