Residential price predictions: Which major Australian markets have spare borrowing capacity?

Residential price predictions: Which major Australian markets have spare borrowing capacity?
Residential price predictions: Which major Australian markets have spare borrowing capacity?

I am often asked how one can predict residential price growth. 

Well, the only way I know how – with any form of logic and indeed, accuracy – is based around borrowing capacity. 

Spare borrowing capacity by itself doesn’t automatically mean the prices will rise; nor does over-borrowing – in isolation – result in prices falling.   

But what often comes true is that if there is spare capacity in concert with tight supply, rising sales and improving buyer confidence, then prices often do rise.  Of course, the reverse also applies. 

So which major Australian markets have spare borrowing capacity?  Which ones are already pushed to the limit?  Read on….

Assumptions 

In a similar vein to our recent missive on housing affordability, we have made some assumptions. And in this regard we did the following: 

  • Went to the 2011 Census for each capital city and found the median family household income.
  • Worked out – via average weekly earnings – which are updated by state/territory twice each year – how much, by proxy, family incomes may have risen since the last census.
  • Applied a basic online ‘how much can I borrow’ calculator using a principal and interest loan; 30 year time frame against several levels of interest.
  • Used AFG’s mortgage index to determine the average loan to value ratio for each state/territory.  We used this to determine the average level of deposit in each case.
  • Recorded dwelling prices by capital for all dwellings according to the latest release from RPData.

Interest rate settings

We used five interest rate settings.

  • 5.2% – which is the average rate for a current three-year fixed loan, according to the RBA.
  • 5.95% – which is the current average variable rate, again according to the RBA.
  • 6.25% – which would represent a 0.25% movement upwards in the cash rate, based on the current average variable rate.
  • 6.5% – or a 0.5% movement upwards in the cash rate.
  • 7.5% – or the average variable interest rate over the last 20 years.

Our aim

Our aim here is to find out two things: 

  • The degree of potential price movement based on today’s record low interest rates
  • The possible impact rising interest rates would have on borrowing capacity and its potential impact on prices

So here are some of the results – all for March 2014.

Sydney

Median dwelling price                                                          $762,000

Median family household income                                           $97,500

Maximum borrowing capacity at 5.2%                                   $675,000

Maximum borrowing capacity at 5.95%                                 $620,000

Maximum borrowing capacity at 6.25%                                 $600,000

Maximum borrowing capacity at 6.5%                                   $585,000

Maximum borrowing capacity at 7.0%                                   $530,000

 

Melbourne

Median dwelling price                                                          $669,000

Median family household income                                           $93,500

Maximum borrowing capacity at 5.2%                                   $590,000

Maximum borrowing capacity at 5.95%                                 $550,000

Maximum borrowing capacity at 6.25%                                 $525,000

Maximum borrowing capacity at 6.5%                                   $515,000

Maximum borrowing capacity at 7.0%                                   $465,000

 

Brisbane

Median dwelling price                                                          $482,000

Median family household income                                           $89,750

Maximum borrowing capacity at 5.2%                                   $590,000

Maximum borrowing capacity at 5.95%                                 $545,000

Maximum borrowing capacity at 6.25%                                 $530,000

Maximum borrowing capacity at 6.5%                                   $515,000

Maximum borrowing capacity at 7.0%                                   $465,000

 

Perth

Median dwelling price                                                          $615,000

Median family household income                                           $105,750

Maximum borrowing capacity at 5.2%                                   $680,000

Maximum borrowing capacity at 5.95%                                 $625,000

Maximum borrowing capacity at 6.25%                                 $605,000

Maximum borrowing capacity at 6.5%                                   $590,000

Maximum borrowing capacity at 7.0%                                   $535,000

 

Australia 

Median dwelling price                                                          $500,000

Median family household income                                           $82,250

Maximum borrowing capacity at 5.2%                                   $555,000

Maximum borrowing capacity at 5.95%                                 $510,000

Maximum borrowing capacity at 6.25%                                 $495,000

Maximum borrowing capacity at 6.5%                                   $480,000

Maximum borrowing capacity at 7.0%                                   $435,000

Potential price direction

Dwelling prices in both Sydney and Melbourne, even at today’s low interest rates, appear to have overshot the average family’s capacity to pay.

Our analysis suggests, based on a 5.2% three year variable interest rate, that Sydney’s current median dwelling price of $762,000 is 19% more than most living in Sydney can afford.  This ratio is 16% in Melbourne.

In contrast, and again using a 5.2% interest rate; Brisbane’s dwelling prices could increase by up to 14% before maxing out the average Brisbane family’s borrowing capacity.  Perth has about 9% spare capacity; and on average across the country there is about 7% potential dwelling price growth, given the present low interest rates.

Adelaide, Hobart, Darwin and even Canberra have some room to move – based on spare borrowing capacity and current low interest rates – when it comes to dwelling prices.

Rising interest rates

Rising interest rates could see price falls.  This is especially the case in both Sydney and Melbourne and to some degree in Perth, Brisbane and Canberra.  

A 0.25% lift in interest rates could see a 1% fall in Australian house prices.  A 0.5% lift in interest rates could mean a 3% to 5% fall in real estate prices is possible.  If variable interest rates went back to their longer term average of 7.5%, the dwellings prices could fall by as much as 10% Australia-wide.

Could rise and fall

Now they could fall; just like they could rise further across much of the country, given the current low interest rates.  

As said at the beginning, a range of other factors – supply, sales direction and confidence for example – also impact on a residential market’s direction.  

Additional factors

As seen in the case of Sydney and Melbourne – and as is now starting to emerge in Brisbane’s inner city new apartment market – several additional factors are pushing prices beyond even the maximum price levels rationalised by historically cheap interest rates.  

These include:

  • Chinese buyers seeking a safe harbour for their money and attracted, to some degree, by our favourable exchange rate.
  • Demand from self-managed super funds – burgeoning from the current ability to borrow for residential assets and by the banks pushing SMSFs to borrow, to help fuel their credit growth.
  • Human exuberance – we are like lemmings – there is no other way to describe it.

Final word

At present, purchasing power or the amount you can afford to borrow at prevailing low interest rates, is a major determinant of current dwelling values.  If buyers choose to max out their borrowing capacity, then dwellings prices across much of the country have got some way to grow yet.

Other factors have and are continuing to push some local price points beyond what’s rational. Interest rates, in time, will normalise.  Those markets which have broken logic are very likely to see price falls.

Buyers should be thinking about the worth of a dwelling based on a more normal interest rate setting, before bidding on it.  Investors need to think about local rental returns rather than inter-city price comparisons.

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Michael Matusik

Michael Matusik

Michael Matusik is the founder of Matusik Property Insights, which has helped over 550 new residential projects come to fruition.

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