Westpac forecasts strong rent rises

Even at that pace, however, it will take four years to restore equilibrium between rents and house prices, and that is assuming an eventual normalisation of mortgage rates, the bank’s latest economic commentary says. If mortgage rates instead remain at current levels, it will take 5½ years to restore equilibrium.

Houses are now grossly overvalued, Westpac economist Brendan O’Donovan says, and he forecasts that prices in five years’ time will be similar to today.

“With rental yields at 4% and mortgage rates at 9%, property investment is looking less attractive,” he says.

“We actually expect mortgage rates to go higher next year, putting even more pressure on the housing market.”

The Westpac “investor value of housing” measures the value of property as an investment asset, according to prevailing long-run interest rates, marginal tax rates, rents, and expected capital growth.

The investor value was $328,000 in December 2006 – similar to the actual selling price of property at the time. Since then, rising mortgage rates have dragged the investor value down to $260,000. Meanwhile, the median selling price has risen to $350,000

Even if mortgage rates returned to average levels, the investor value would be $300,000, still leaving a gaping overvaluation.

The lower end of the market will be weakest, since the most vulnerable owners are highly leveraged property investors and recent entrants, says O’Donovan.

If tax cuts eventuate, they will tend to depress lower-end prices further, since lower tax rates reduce the incentive for holding rental property as a tax shelter, he says. Conversely, tax cuts would benefit the top end of the market, thus generating greater price dispersion.