Just over 20 years ago, in 1995, an “average” Australian home could be bought for about 3.8 times the average weekly earnings.
Today, that same ratio is 6.5 times average weekly earnings. So on the face of it, Australian homes today are almost twice the relative prices as they were 20 years ago – see the chart below.
This is the reason that some overseas doomsayer economic commentators offer for the impending housing bubble bursting and Aussie house prices to come crashing down. Simply because of a price to income ratio (PIR). They contend that because the relative price of housing has lifted above its long term average that it must surely at some point revert to its mean. In some respects they are right – at least partially. I think that the housing price to income ratio is likely to adjust backwards in time, but not in the form of a crash – there is simply no economic reason for it to happen. The change is likely to be more gradual.
Recently, home price increases have been moderating, while prices in Perth & Darwin have already dropped from their peaks. So the PIR in those two cities is already looking better. If wage growth was to re-ignite, that also would change the income side of the ratio, though there is a current argument to say that is not likely given the low inflation rate we are experiencing.
What the doomsayers from far away fail to explore is that there are two significant factors which have contributed to the much higher price to income ratio than just higher prices. What they miss is that the average weekly income 20 years ago is very different to the average weekly income now. And that might sound like Double Dutch, but the average weekly income is now more likely to be made up of incomes from more than one person. The number of employees per household has risen in line with much increased female labour force participation. This has led to much higher annual earnings – per household. This can best be demonstrated by examining the chart below, which compares annual earnings versus average earnings, as the chart above uses. Annual is very different to average. The chart below compares mortgage payments as a proportion of annual earnings.
You can see that while the rate is slightly higher than 20 years ago, it is by no means twice as high – as you would expect if you took in to consideration the almost doubling of the price to income ratio.
So taking a single statistic – the PIR – on its own is not always a reliable way to predict what could happen. The other major factor that has influenced the mortgage repayment chart above is the much lower interest rates we now have. In June 1995, the official interest rate was around 7%, compared with 1.5% now. That has helped ease the burden of higher prices.
The real challenge may come when interest rates inevitably rise again. And you can be sure they will, though I can see no reason at the moment for them to do so. Unless wages rise and/or house prices moderate before then, we could very well be facing a much tougher housing market than we have even today.
And that is my concern looking forward.
One of the most important things you could do in the intervening time is to either pay down the level of debt you have, or if you don’t own a home yet, buy one and work to pay down the mortgage.
To do that a low interest rate always helps. If you missed my Radio Wealth podcast from last week, you will have not heard some of the most exciting news around home mortgages I have seen for decades. I shared some news about a home loan that could potentially have an interest rate as low as 2% – there are conditions around this – you need to have your own home and at least one investment property and of course you need to be able to qualify for the loan as you would with any other lender.
But 2%? Wow!
To catch that broadcast, just click here.
It makes sense to get the best interest rate you can, and as far as I know this is the best in Australia, which is why I’m so excited to be able to share it with you.
Yes, our prices globally are considered technically high on some measures. But it does not mean that you should sell what you have and rent or to refrain from buying your own home. Far from it. Real estate prices can wax and wane with the cycles, but over the decades, even the centuries, through economic boom and depression, the long term trend for real estate prices has only one direction.