How far house prices have soared above fair value

Australian house prices are overvalued by more than a third, and are getting worse in many locations, new analysis shows.

But prices are not tipped to return closer to their fair value unless significant amounts of new housing are built.

House prices are far above fair value.Credit: Dion Georgopoulos

House prices nationally are 34 per cent above fair value, the analysis of Real Estate Institute of Australia data by AMP chief economist Shane Oliver found – an increase of five percentage points since March.

The research compares median house prices with average rents across capital cities, in a series that dates back four decades.

Sydney reported the highest overvaluation at 47 per cent – up from 32.8 per cent – followed closely by Brisbane at 45 per cent, from 33.5 per cent.

Canberra and Adelaide were overvalued by 38 per cent and 33 per cent respectively, and Perth sat at 12 per cent above fair value.

Melbourne was the only capital city to edge lower, down to 17 per cent from over 25 per cent in March.

Oliver started comparing median house prices with the average rents in each capital city, excluding Darwin and Hobart due to lack of data, in December 1983. The gap persists even as rents have jumped in recent years.

“The results haven’t changed a whole lot from where they were earlier this year,” he said.

“Houses prices have generally gone up, although inflation has come down a little bit, but the basic picture is still one of overvaluation, especially when it comes to houses pretty much across the board.

House prices have stayed overvalued for years.Credit: Rhett Wyman

“Sydney needs to fall about 32 per cent to get back to fair value, Perth needs to fall about 11 per cent and everywhere else is in between,” he said.

Building more homes, Oliver added, will be key to reducing the overall overvaluation and then keeping prices down in other cities.

The research comes as the federal government this week moved to address sky-high housing costs through a shared equity scheme to boost home ownership and enabling more build-to-rent developments to offer tenants more security.

Property values have been weakening this year in the face of higher for longer interest rates, but remain at unaffordable levels. The typical Australian home costs eight times the median household income, a record high. A hypothetical first home buyer would need to pay more than half their income in mortgage repayments.

Managing director of SQM Research, Louis Christopher, agreed that the Sydney house market is stretched in terms of its valuation, but it has been that way for quite a while.

“Based on our metrics which are determined by comparing house prices to nominal GDP, Sydney is the most stretched, we’ve got it at just over a 20 per cent overvaluation, but the interesting thing is that on average, since 1986 on our numbers it has been 20 per cent overvalued,” he said.

“There have been brief times like in 1994 and ’95 where it has come back to fair valuation, but generally it always trades above its fair valuation.”

The cities that are “less stretched” Christopher said, include Adelaide and Melbourne.

But he still thought Melbourne values were about 15 per cent too high.

“The long-term overvaluation has been around 9 per cent. There have been times when it has been undervalued, including the early to mid-1990s, but of late, because of the correction occurring in Melbourne with the flatlining of prices this year, it has been returning to fair valuation.”

He said Adelaide’s property market offers fair value.

This, Christopher believes has to do with the smaller rise in Adelaide’s economy and population, compared to Sydney, as well as a reduced cost of living.

With a 5 per cent overvaluation in Australian capital cities, unit valuation tells a different story, Oliver said.

“The overvaluation isn’t as dramatic, with the capital cities prices at about five per cent over what they should be, but Perth is undervalued by ten per cent and Hobart is overvalued at nearly 40 per cent due to the boom in the pandemic,” he said.

Melbourne was the second most undervalued in terms of both houses and units, its “weak price performance” Oliver said is due to a combination of factors.

“In recent times – the slow recovery from the pandemic, higher interest rates in 2022 and modest gains since then – it hasn’t managed to get back to its post-COVID highs,” he said.

In future, Christopher believes the results will vary from city to city.

“We think Sydney house prices are falling, but it is unlikely that it will turn into an undervalued city any time soon.”

While in Brisbane – up until it hosts the 2032 Olympic Games – overvaluation of houses will continue, he believes.