Housing bubble cause of price-rent ratio movements in outer Sydney
AUTHOR: Jared Reed DATE: 06.09.07 ISSUE 1, 2007
The geography of a suburb in Sydney plays an important role in its housing price-rent ratio, according to a new UNSW research report.
A speculative bubble in housing prices in Sydney’s outer regions has been the most likely cause of fluctuations in price-rent ratios in these areas over the last fifteen years, according to the report from the Australian School of Business.
| Associate Professor Glenn Otto's research suggests that the fundamental driver of Sydney property prices is changes in the discount rate used to value rental income or utility flows. |
Median rent and house pricing data collected between 1991-2006 from outer-ring local government areas (LGAs), including Fairfield, Liverpool, Blacktown and the Blue Mountains, showed that up to 60% of price-rent variation was not caused by changes in fundamental market factors such as rent growth, variation in housing returns or real interest.
This was in contrast to nine-inner city LGAs, where changes were explained by a variation in future housing returns – meaning these areas are ‘bubble-free.’
"During Sydney’s recent housing boom, some properties sold for 40 times their annual rent in 2004, up from 15-20 times in the mid-1990’s,” said Associate Professor Glenn Otto, research co-author from Economics at the Australian School of Business.
"The UNSW research set to discover whether speculative bubbles, when house prices rise independently of fundamental factors, accounted for this behaviour.”
The research tested 36 LGAs by examining whether price-rent ratios were able to forecast real growth in rents, but found Sydney property prices were not driven by expectations of future rent growth.
"In most LGAs the price-rent ratio predicted real interest rates and property returns. This suggests that the fundamental driver of Sydney property prices is changes in the discount rate used to value rental income or utility flows,” said Associate Professor Otto.
"As buyers and sellers came to expect the decline in real interest rates during the 1990’s to be permanent, they revalued the flow of rents or utility services associated with residential housing, driving up market prices relative to rents,” Associate Professor Otto said.
Either the fall in real interest rates caused this, or a revaluation of risk in housing was the reason, said Associate Professor Otto.
"The observed rise in price-rent ratios requires a significant fall in the risk premium on residential property in Sydney. It must be the case that individuals believe that housing has become a better hedge against bad economic times.”
Empirical findings in the report confirm that future real interest rates will be an important influence on the level of Sydney house prices.
"If housing market participants expect a sustained rise in the real interest rate, our results suggest this will cause a decline in the price-rent ratios across all areas of Sydney,” Associate Professor Otto said.