Sydney house prices need to drop 25% for future affordability

Deutsche Bank’s chief economist Adam Boyton found that a “reasonable relationship” had grown between borrowing power (that is, a function of income, interest rates and mortgage length) and house prices in Sydney.

Mr Boyton highlighted the amount of money the average household could borrow over time has more than doubled, from $125,000 in 1995, when Sydney housing “was very affordable”, to $485,000 in 2015 – an increase of 288 per cent.

At the same time, house prices in the area have risen by 283 per cent.

Mr Boyton said he believed that the more pressing issue in Sydney’s housing market had less to do with mortgage repayments themselves, and more to do with issues of equity and the ability of people entering the market in the first place.

“If we instead consider the question of entry into the housing market – namely what share of income does a 20 per cent deposit require – the lack of affordability becomes clearer,” he said.

However, he added: "It is, to be sure, easier to identify this issue than it is to solve it – particularly in the near-term. After all, it would take a ~25% drop in house prices over the next few years to bring the deposit as a share of annual income back to the 20-year average. And of course the experience of other economies that have seen such a drop in house prices over a two year horizon would suggest such an outcome would be highly undesirable given potential impacts on the banking sector and the broader macro-economy."

Deutsche Bank's research suggests that the dominant source of widespread escalation in housing prices has been due to a surge in demand well above the normal expected increases associated with population and income growth, “to which supply was inherently incapable of responding”.

“If this increase in supply manages to hold dwelling prices around current levels, then income growth and time should… work to lower the current very high hurdle to a deposit,” said Mr Boyton.

The bank's chief economist said he also believed that the ability of policy makers to increase the accessibility of housing to those not currently in the market is, in the near term, “likely to be limited [but]…that does not mean that there are no options available to policy makers”.

Mr Boyton suggested that policy changes to make renting in Sydney a more desirable long-term scheme with greater stability for tenants might be in order while housing prices go down.

“The good news is that the interest rate reductions of recent years have driven a surge in dwelling construction. In other words, there is supply increasingly coming on stream [and] with this new supply… likely to put downward pressure on prices.

“That doesn’t mean that prices will necessarily fall, but that prices will be lower than they otherwise would have been in the absence of such an increase in supply,” Mr Boyton concluded.

[Related: Bubble risk ‘eminent’ in Sydney]