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High prices for Sydney property or just regression to the mean?

David Bassanese
Wednesday, June 24, 2015

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By David Bassanese

The latest official housing data from the Australian Bureau of Statistics confirms the major discrepancies in price performance between Sydney and the rest of the nation. A number of inventive reasons have been suggested for this discrepancy – such as negative gearing – but it also seems what we’re seeing is a simple case of regression to the mean.

According to the ABS, Sydney residential property prices surged 3.1% in the March quarter, to be up 13.1% over the past year. The next best city was Canberra, where prices rose by only 1.1% last quarter. Outside of Sydney, moreover, no capital city had annual price growth of more than 5% - with even Melbourne prices up only a moderate 4.7% over the past year. 

Why is this so? Amid all the hysteria around Sydney house price gains, we’ve quickly forgotten the long period in which Sydney prices were sluggish. In the eight years to the December quarter 2011, for example, Sydney house prices rose by a mere 10%, (1.2% per year) whereas national house prices rose by 40% (4.3% a year).

According to the ABS data, the average Sydney house price during the March quarter was $786,000, or 32% more than the average Australian house price of $597,500. It just so happens that’s equal to the average house price premium Sydney has enjoyed on average since June 1990 (based on a splicing together of old ABS house price data). 

As seen in the chart below, Sydney’s relative house price premium sank to a mere 11% in early 2009, but has since recovered to its long-run average. In other words, much of what we have seen in recent years is merely catch-up – restoring Sydney to its usual preeminent house price premium compared to other states.



Note also what happened when the previous Sydney property boom ended in 2003 – a lot of investor interest flowed to other cheaper states – such as Brisbane, Adelaide and Hobart. 

On top of this, we had the mining boom, which created super-charged house price gains in Darwin and Perth. Indeed, the chart above suggests Perth property prices enjoyed a spectacular bubble which peaked in December 2006 – when the average Perth home was briefly worth more than that in Sydney. 

The cheaper states and the mining boom states have been paying for their earlier strength since the end of the mining boom – with underperformance relative to Sydney. In a sense, therefore, the current Sydney centric housing boom is not that unusual. 

One concern, of course, is that Sydney prices have now become quite high relative to average earnings in the state – modestly exceeding the peak during the last boom a decade ago. At least in part, however, this is a consequence of today’s much lower level of interest rates - which has meant overall Sydney mortgage affordability still remains better than at the peak of the previous boom. Ominously, that suggests Sydney prices could keep rising for a time, especially if the Reserve Bank cuts interest rates further – as I expect. 

The good news for other states, however, is that price relativities are now moving back in their favour. Relative to their long-run average, Brisbane, Adelaide, Hobart and Canberra are now relatively cheap compared to the national average. 

If history repeats, and the Sydney house price boom eventually hits affordability constraints, investor interest might, quite reasonably, move to where better value can be found. As for the mining states, their relative performance could sag for some time longer. 

Published: Wednesday, June 24, 2015

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