Disconnect between rents and house prices suggests housing is overvalued: Philip Soos

By Larry Schlesinger
Monday, 04 February 2013

The “wide gulf” that exists between prices and rents suggests that housing in Australia is overvalued, argues Deakin University researcher and housing bubble proponent Philip Soos.

Soos points to RP Data’s most recent Buy vs Rent, which he says shows that unless you’re willing to buy in remote or unattractive locations, it’s cheaper to rent then own property.

The RP Data report found that out of 5,230 suburbs, there are 388 suburbs that are cheaper to buy than rent based on a standard principle and interest home loan. This rises to 1,031 suburbs if borrowers are willing to pay an extra $50 a week in mortgage repayments.

While a more realistic study would factor in costs such as "maintenance, council rates, water and sewerage, land tax, body corporate levies, stamp duty, and legal and conveyancing fees" Soos says it does provide some evidence to suggest a "confirmation of overvaluation in the residential real estate sector, that is, the market price of property is significantly greater than future rents capitalised”

As further evidence of this claim, he points to the rising ratio of real house prices to rents which have increased by 64% from trough to peak (1997-2007) with some moderation recently due to falling housing prices and rising rents in the last two years.

Currently the ratio is about 160% (house prices to rents) and Soos says it serves as one of many indicators to determine possible overvaluation in the real estate sector.

“It comprises a valuable metric and thus should not be ignored,” he says.

According to Soos, this divergence between house prices and rents suggests “confirmation of overvaluation in the residential real estate sector, that is, the market price of property is significantly greater than future rents capitalised”.

Furthermore, he says it indicates the Australian property market is not operating in an efficient manner.

“Conventional economic theory stipulates that, in an efficient property market, the all-in risk and tax-adjusted cost of purchasing a property should equal the cost of renting it,” writes Soos in a column for Business Spectator.

“If buying is dearer than renting, then supposedly rational individuals will change their preference by selling, taking the profit, and renting, driving down housing prices until the cost of buying equals the cost of renting,” he says.

Soos says what is driving up the difference between house prices and rents is “debt-financed speculation”.

While rents are determined by wages and what tenants can afford to pay, capital values are driven by banks willingness to provide finance to home owners and investors “limited only by lending regulations (if banks choose to observe them) and borrowers’ ability to service the mortgage repayments”.