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House Prices in Western Australia

Perth, Australia: housing market

This analysis is done far from the place in question. I am going from figures given for various indices, and clearly I have to accept them, but cannot check them. So, how do I go about analysing the housing market in Perth, Australia?

First, I need to know what the average house price is, what the average rental figure is, what average wages are, and what the affordability index has to tell me. I then marshall those figures to give me an overall picture.

I would like to compare house sales with rentals. The cost of the mortgage should equal the cost of the rent plus or minus 20%. Any figure further out than a 20% variation will show that price to be either too high or too low. However, I cant make that calculation as I dont have access to the figures.

Let's now turn to the underlying principles of expensiveness. The whole concept of an affordability index was developed by me rather a long time ago when I was still at college, and the idea was sold to a Canadian company. The concept has been changed, or tweaked subsequently by many entities, but the underlying concept is disarmingly simple.

The index is supposed to be an indicator showing when houses become too expensive to be affordable, and thus this unaffordability will impact on the ability of prices to increase, and thus warn potential purchasers that maybe now is not a good time to buy. Conversely, if the index is low, then maybe now is a good time to buy as there is room for prices to rise.

As an indicator the index as now generally used is useful but not conclusive. Prices notoriously in Vancouver and Hong Kong have defied gravity for years. This is why my original version of the index tracked tipping points. I dont have a database of figures in order to be able to do this for Western Australia, but to give you an example of what I mean, this is how the tipping process works in the UK.

In the London area people are generally prepared to spend up to 60% of their disposable income on housing. In the South-East that figure is even higher, however, in Scotland the figure is just 40%. And the figures vary across the UK.

This means it doesn't so much matter whether the figure is high or low so much as where the tipping point is. If house prices reach a level where the mortgage is costing more than 40% of income in Scotland you can assume that prices have reached a ceiling. Similarly, if the cost is 60% of disposable income in London, then prices are as high as they are likely to go.

Knowing these figures gives you a certain handle on whether house prices have reached a top.

However, the general definition of affordability is given as a generalised figure that can be, in theory, used throughout the world. In reality it has severe limitations. It starts with the presumption that affordability is normal when an average mortgage costs between three and four times earnings. The higher costs go above this figure, the more unaffordable a house is, while the lower it goes, the more affordable it becomes.

The table I usually use can be found at www.demographia.come/dhi.pdf

The basis for this is that a typical homeowner/worker will be able to get a mortgage of three times income (+ 1 if the partner is working also). Prices beyond that point indicate increasing difficulty in making mortgage payments, and will, at higher levels, put the transaction at risk of interest rate rises.

This means house prices which give us a figure above 4 show they are theoretically above sustainable levels.

I also recognise the old adage that market prices can stay irrational longer than one can stay solvent. Hence everything following is for guidance only rather than an indication that prices may or may not change. My original affordability index would give the crucial tipping figures, but as mentioned earlier, I dont have the data for WA.

Australia in general exhibits an affordability index of 5.6 which is well into expensive territory. (This figure is for last year. Things would appear to have improved slightly over the course of this year.) Perth is in this unaffordable zone at 5.9, and therefore house prices are currently higher than is sustainable in the longer term.

A way of getting a closer handle on the local situation would be to find the average wage in Perth, then the average house price, and see whether you have mortgage costs coming in under 3 times income, or over 4 times income. In the median zone, prices are what you might call normal. Above they are unaffordable, while they are easily affordable below that zone.

Now look to refine that down to the house type you are interested in by using rental and sales websites.

You would also look at local equivalences. Long time readers of my work will know I am a keen mathematician, and I have great respect for the equals sign. The equation I would use in this instance is simplicity itself. Housing costs are housing costs. If you live at number 3 and I live at number 5 and we both live in similar houses then our housing costs should be broadly similar. If you rent and I buy through a mortgage, then the cost of the rent should be roughly equal to the cost of the money.

If one figure gets more than 20% out of line with the other than look for a reversal. People dont like paying over the odds for anything, and if you can rent and get largely the sale deal as me on a mortgage, and my mortgage is costing a lot more than your rent, I'm going to change my style.

Lastly, look at the prospect of interest rate rises, and the economic situation. Gauging interest rates moves is difficult, but if wages are rising, expect house prices to rise also, but if they are falling, then expect stasis, or falling prices.

I trust this not only helps, but provides a simple methodology for working things out on some future occasion without further outside help.

All of this is dealt with in much more detail in my book on property matters: The Property Expert's Bible. (Click the link for details.)


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