Over the last few weeks we have been running an affordability analysis on Australian property. Our framework was as follows:
- Obtain Median Household Incomes (ABS), e.g. $51,896 in 2014.
- Define a reasonable expectation of a deposit
- assuming households save 40% of income for 5 years
- this is aggressive but caters for both those willing to save to own and might be living with parents and if they had other savings or hand-me-downs.
- Result: a deposit equal to 2 years household net income
- Determine required mortgage from the above deposit and observed median house price (ABS), i.e. 2014: 100% less 18% deposit = 82% of median house price. Median House Price 2014: $571,700. 2014 Required Mortgage: $467,908.
- Consider achievable serviceable mortgage from observed variable rate mortgages (plus serviceability buffer) and household net income. Say 4.5x Household Net Income, but driven by a slightly more complex equation. 2014: $231,937.
- Look at how many multiples the required mortgage is above the achievable serviceable mortgage. 2014: 2.02x. Average: 1.69.
There are a few things to note:
- Median Income does not buy median house. Top earners will have multiple properties whilst lower earners will never own. However this analysis serves 2 purposes:
- how has this relationship evolved
- which percentile of household income can actually afford the median house
- Achievable mortgage is calculated from inputs and factors that we will not discuss but is roughly derived from:
- interest rate + 3%
- 40% of household net income to service that debt
- hence a median current household income of $51,896 would have an achievable mortgage of $231,937 (about 4.5x net household income) if the current interest rate (SVR) is 5.95%
A. Households cannot save as much of a deposit. In 1994, households could achieve a 29% deposit under our hypothesis. It has declined to 18%. Note: this is a major constraint for first time buyers whilst existing property stock holders can release equity in their property for further purchases.
B. The ratio of required mortgage to achievable mortgage has been increasing, meaning the median household is further away from being able to afford the median house. Note: the dip into 1998 is a function of interest rates declining but house prices remaining relatively static.
C. The Percentile of Household income required to buy the average house has trended heavily upwards and now you need to be in the 90th percentile of household income to buy the Median (50th percentile) house.
We draw several conclusions from this:
- We can use #B to suggest Australian property is about 20% overvalued on an affordability basis. We note the risk of averaging here.
- The ability to raise deposits has become difficult (#A) but LMI and lower deposit requirements have solved this problem in some ways.
- If you need to be in the 90th percentile to buy the media house price, based on this simple analysis, we see 2 things:
- The average person is leveraging too aggressively to buy property in such a way that they are acquiring a mortgage they may struggle to service (ie the 70-80th percentiles are still buying a median house that is only affordable by the 90th percentile). We note the average borrower is taking 5.3x net household income in Australia from Macquarie via Clancy Yeates, or
- The 90th percentile and above are accumulating more property, possibly distorting household income with negative gearing, and that pocket of what is ultimately investment property, is deeply over leveraged.
Any potential solutions?
- 20% price downward correction, although this will impact those who are over leveraged but support those who are under-leveraged.
- If borrowers can lock in lower interest rates for longer periods (such as the Huffle 10-Year Fixed), then the serviceability issue may reduce and households with lower percentile incomes can confidently borrow more.
- There is potential need for the severe reduction of property investment if we want average Australians to be able to own the average house.