Thursday, November 4, 2010

Lies, Damned Lies, and Housing Statistics

            Get your facts first, then you can distort them as you please.
                -  Mark Twain
The Great Affordability Swindle

House price to income ratios may seem a bit dry for a first post.  Nevertheless I would ask that you bear with me as I discuss one of the cornerstones of understanding Australia's housing market.  After much discussion over the last few years, the Australian housing market bubble debate took a seriously weird turn when attention turned to debating the merits of competing 'price to income' ratio methodologies.  Even if you are not an egg-head interested in economic data, this analysis is interesting...and scary!

For many years the debate about Australia's unaffordable housing market raged.   We will spend lots of time going through these various arguments in future posts (you know the drill: housing shortage, high population growth, cultural affinity to property, strong banking sector, etc etc).  The argument about 'bubbles' is largely about affordability though. 
Those who are convinced there is a property bubble in Australia will often point to our house price to income ratio as evidence that prices are reaching an unsustainable levels and are due to correct (i.e. reduce).  In simple terms this ratio is defined as:
Price to Income Ratio = Median House Price / Median Disposable Household Income
One way of interpreting this is how many years it would take (with no other expenses) to save for a 'middle of the road' house with a 'middle of the road' income.  Sounds like a sensible test for affordability, right?
Demographia Data
One of the most helpful sources for this information in recent years has been Demographia (  Their annual survey publishes 'median multiples' across urban areas in the US, UK, Ireland, Australia, Canada and New Zealand.  To be clear, the survey looks at both median 'price' and 'income' levels for major urban areas in all of these six comparable developed nations, and generates a ratio of median price/income for each.  The higher the 'median multiple' in a given city, the more unaffordable it is.
Over recent years the preponderance of Australian cities in this survey among the most 'severely unaffordable' has been given considerable media coverage (if for no reason than the Australian media's unending ability to sell papers when anyone discusses the question of whether house prices are over-valued!).  The 2010 Demographia survey was the most scathing yet of the level of affordability in Australia, and was used by a number of commentators and investors to justify their highly publicized views that Australia's housing market is overvalued.  The top ten most unaffordable cities according to the 2010 survey were:

To rub salt into the wound of Australia's housing market supporters, the survey also summarized the results of its survey by country as follows:
The conclusion of this survey is that only one of twenty-three major urban real estate markets in Australia is not 'severely unaffordable' according to Demographia's methodology, and that market is still 'seriously unaffordable'.  This level of unaffordability massively exceeds any of the other nations in the survey.

Other Median Multiple Data

Other commentators, such as GMO founder and chief investment officer Jeremy Grantham, have made a lot of headlines quoting price-income ratios which, while lower than Demographia, are still much higher than historical levels and much higher than the levels seen in other nations.

Gratham has been quoted as saying: "The price of housing typically trades about 3.5 times of family income and in bubble it goes to 6 or.. 7.5 (times)”... "you are at near 7.5 times family income... which suggests you are twice the size that you should be." (The Australian, 16 June 2010)

The main difference between Grantham's numbers and Demogaphia's appear to be Grantham's use of median price for all dwellings as the numerator in the ratio, wheras Demographia appear to use house prices only,  which is a material difference. 

Nevertheless the result of both Demographia and Grantham's numbers are the same: a clear indication of the historically stretched valuations being ascribed to Australian houses.

The Empire Fights Back
Unhappy with these turn of events, and even more unhappy with a simple and straightforward comparison to international affordability metrics, the Australian property lobby fought back.  For many years the mouthpieces of the property lobby were content in relying on the 'stock vs flow' argument for why such damning data was irrelevant.  In other words, the idea that any comparison of a stock (house prices) with a flow (income) was bound to be inaccurate.  A related argument against such 'crude' measures of affordability was the idea that the level of mortgage repayments (driven by interest rates) are more important than the level of price and income themselves.  I will address these propositions in a future post, but to preview, this argument is only reasonable if one considers long term interest rates, not current interest rates - after all it is a 30 year mortgage!  Suffice it to say that many people could see through the chimera.  Thus, the property lobby had to attack the affordability ratio itself and find away to make it more pliable to their tale.
Bullish property commentators such as Christopher Joye realized that Demographia and virtually everyone that was tracking affordability was using Australian Bureau of Statistics survey data for the 'median household income' portion of the affordability ratio discussed above.  So they uncovered a 'better' source for household income: the national accounts used to calculate GDP.  As described in this post, Joye claims the national accounts defnitition of household income is better for two reasons: 1) the household survey data is "dated" being a 2007 study whereas National Accounts data is released in a much more timely fasion; and 2) "earnings on savings and investments" should be included because "people buy homes out of disposable incomes rather than wages".
As I note below these are somewhat spurious reasons to use the National Accounts data as 1) it is very easy to adjust the 2007 numbers for subsequent wage/income growth (as I do below) and 2) there are a number of sources of 'disposable income' in the national accounts which contratary to Joye's post are not actually available for people to "buy homes" (such as superannuation contributions and 'imputed' rental income).  More on that below too.

To cut a long story short, the numbers that Joye used imply that the ratio of house prices to incomes is actually closer to 4 to 5x which - surprise, surprise - is in line with other developed nations.  The most recent incarnation of this logic has been recently updated by Joye here and here, which provides a useful snapshot of the way in which this 'modified ratio' is being used as a debating weapon.  I examine the different numbers below, but the short answer on how a ~50% reduction in the affordability ratio is conjured up is that they 'find' additional disposable household income of over $20,000 compared to the ABS survey data.  Oh, and they use the average household income rather than the median which is worth about another $12,000 in annual income (because the highest income earners 'drag up' the average).  The 4-5x ratio implies that the disposable household income that should be compared with the median house price, across Australia, is ~$95,000.  This is the after tax level of household income.  With 25% effective tax rate this implies a gross income of $125,000 is what the 'median' household earns in income that can be spent on bills, food and mortgage payments. 
These numbers have been picked up by all the usual suspects wishing to argue that the affordability problem is, err, not really a problem.  Once the RBA started using this data it was on for young and old, including the big four banks who have begun parroting these same ratios in their presentations, shamelessly using them to 'alter' the unfavorable international comparisons applied to the asset class that chokes their balance sheets and income statements - residential property lending.
Westpac's effort here (pages 8 and 9, and chart 7, in particular).
CBA's effort here.
The CBA's alteration of the international affordability comparisons was perhaps the most clumsy and crude, but you have to give them marks for being brazen!  Note that my comments to the right were not in the CBA's charts released to investors, showing that they adjusted the Australian numbers but not the international comparisons.  For more background on this cheeky effort, see this Steve Keen post which picked up on Kris Sayce's initial discovery of this chimera in his Money Morning blog.
Decoding the Numbers
All of this begs the obvious question: how can two official measures of household income be so different?  Before providing a quick reconciliation of the numbers, here's what they are.
a) The ABS median household income survey

The most recent ABS household income survey was conducted in 2007/2008 and can be downloaded here.  Details of the methodology employed by the ABS in this survey can be found here.

In summary the ABS data involves a survey of individuals living in dwellings, and counts income that as a general rule is "available for consu mption" - in other words cash or cash like in nature and available to meet cash obligations.   

b) The national accounts household income data
The national accounts data is essentially designed to count all economic production and activity in every given period in order to calculate (among many other things) GNP and GDP.  These sources of economic activity are in many cases non cash sources of income to household, or otherwise unavailable to be actually spent.

In using this data to come up with a measure of 'household income' the banks have divided the aggregate proportion of Australia's GDP apportioned to the Household Sector in the national accounts by the total number of households according to the ABS.
c) Bridging the gap

The ABS published the following statement as part of its 2007/2008 household income survey:

The concepts of income used in SIH have many similarities to the household income definition used in the Australian System of National Accounts (ASNA), but also differ in some respects. A detailed comparison of 1997–98 SIH and ASNA estimates was published as an appendix to the 1997–98 issue of Income Distribution, Australia, 1997–98 (cat. no. 6523.0). Comparison of SIH data from 1994–95 to 2007–08 with ASNA data indicated that the relationship between the two estimates had not changed significantly over that period. [Link Added - from page 55]
I have used this 1997 reconciliation between the national accounts data and the household income survey to provide a bridge between the two sets of numbers.  I happily accept these are somewhat 'rounded' numbers, but the ABS has specifically noted that the relationship "had not changed significantly over the period", so this should provide a reasonable estimate.  My approach has been to take the 1997 reconciliation and scale the adjustments to the 2008 household income numbers discussed above. 

Before diving into the details, it should be noted up front that the National Accounts data showed 57% higher household (gross) income in 1997 than what was indicated by the ABS household survey.  So to be clear the order of magnitude of the difference seems to be about the same.

One additional adjustment that must be noted is that the national accounts numbers implicitly use an average household income measure, rather than a median.  This is clearly inappropriate in the context of a median house price to income ratio, and so the scale of this adjustment is estimated also using the difference between average and median incomes in the ABS household survey (which should be highly comparable).  I have also grossed up the 2008 figures to 2010 to also aid the comparability (i.e. helping the case of the housing bulls and addressing one of the original reasonse the banks etc gave for using national income data rather than household survey data).

Here is the summary of my analysis:

So what does this analysis tell us?  All of the differences between the higher income number used by the banking sector to support a lower price to income ratio are, in my opinion, very difficult to justify as being useful in an affordability metric.  For example how does the imputed rent of owner occupied homes provide any capacity to afford more expensive house prices?  The inclusion of implied income received from higher housing costs itself seems very ponzi-like, without even looking deeply into the calculation of imputed rent.  Or consider superannuation contributions (the other major difference).  How do superannuation payments, locked up until retirement to fund consumption, facilitate paying higher prices and mortgage payments for a home before retirement?  Perhaps the most egregious difference is the first one highlighted above - the national accounts definition of 'households' include private non-profit organisations like churches and clubs which have nothing to do with actual household's ability to affod their homes and mortgages!!

Finally, the whole purpose of calculating a price-income ratio is to provide some long term benchmark to assess how affordable housing is relative to historical trends, and to enable international comparisons.  The argument made by the banks in lowering the ratio by using the highest possible income figure does nothing to refute the unaffordable nature of current prices relative to historical measures of the Australian price-income ratio.  While the banks argue there are structural reasons for this (esp a lower interest rate environment), this is a very different argument to saying that the ratio is not currently high.  As for international comparisons, this blog has not conducted an in-depth study of the income measures used in surveys such as the Demographia study.  It seems unlikely, however, that relatively obtuse national accounts data would be used to estimate income in the US, UK, Ireland, NZ and Canada, when all of these nations also publish timely household income surveys (I have asked Demographia the question but no response yet). 

Don't Believe the Hype
Based on the above, this blogger thinks the following statements are irrefutable:
- Australian house prices are considerably higher (relative to our incomes) than other developed countries
- Australian house prices are at an historically high multiple of income (however measured), and this increase has particularly occurred over the last 15 years.
- The use of the modified affordability multiple by the banks and several prominent housing industry advocates is at best inaccurate, and appears to paint the rosiest picture possible of the state of the market.   This is not only because of logical flaws in the use of national accounts income as the denominator in an affordability ratio, but equally importantly because of the modified ratio's inappropriate use in international comparisons.
Padding the numbers in this way might make for pretty slides and graphs in bank presentations, but it exposes a degree of delusion and desperation that is truly scary.

And I believe it is misleading.

Note: Here are the excerpts of the key data sources I used for this analysis (source data linked).

ABS Household Survey vs National Accounts Household Income Reconciliation from 1997:

ABS Household Survey 2008 Income Data - Cat. 65230.0 (note that I have used the 'raw' income data from the ABS Household Survey in Appendix 2, not the 'equivalised' income data that is used in most of the survey analysis  - equivalised income is normalised for household size and not appropriate for this analysis):


  1. This is excellent! Very informative and well researched blog post!

    Common sense supports what this article proves...median house prices have clearly skyrocketed way more than median incomes have in recent years. But yet the housing industry does everything possible to cover up how bad the income to house price ratio has become.

    If income has not been fuelling the house price increases in Australia, then it must be debt. I wonder if this blogger could focus on this aspect of house prices in a future blog post...i.e. show how much income has gone up in recent decades compared to private debt levels...then, using the Oz increase of house prices, demonstrate that this housing bubble is a debt-fuelled one.

    Keep up the good work!

  2. Thank you, thank you, thank you!! This needs to be said over and over again. Sydney's house prices are hugely over-inflated, are based on false premises and when the market blows, it's not going to be pretty.
    We're assuming that we're going to have to become a multi-family home when the boom busts and we're planning in that direction. We won't be the only ones.

  3. Absolutely top stuff - well presented. This kind of analysis needs to be in the mainstream media to wake up the dreary masses.

  4. Recent analysis by The Economist identified the magnitude to which Australian house prices have diverged from historic trends. The Economist calculated that Australian house prices are more than 60% overvalued, making Australia the most overvalued housing market of all the countries analysed by The Economist. Additional analysis conducted by Demographia as part of its International Housing Affordability Survey found that Australian house prices were the least affordable of the six countries examined (those countries being Australia, Canada, Ireland, New Zealand, UK and USA). Based on a ratio of median house price to gross annual household income, Australia was considered to have the most severely unaffordable housing market. Also, in August 2010, Goldman Sachs declared that Australian house prices are "25 to 35 per cent overvalued, based on a measure of affordability that takes house prices, income, lending criteria and mortgage rates into account". Furthermore, legendary American investor and bubble expert Jeremy Grantham, Chairman of GMO, has stated that he believes "the two (bubbles) that are (currently) outstanding are the UK and Australian housing bubbles" and that if those bubbles do not collapse, "it will be the first time in history that such a bubble has not broken". Grantham goes on to say, "The U.K. and Australian housing bubbles may be unimportant to U.S. investors, but to bubble historians they look extraordinary. The U.K. event in particular has broken out of any previous mold. Despite the usual cry of "special case", they will decline around 40%, back to trend, as was the case for the previous 32 bubbles."

    Alex Barton
    Australian Property Forum

  5. To CJG - Thank you for your thorough analysis. For quite some time I have been trying to expose Joye and Co for the way they misrepresent the facts on affordability. I am glad you mentioned their use of average household income instead of median. You also mention Grantham's use of dwelling prices rather than house prices which slightly lowers the affordability ratio. Joye and RP Data also use the Dwelling price. Dwelling price takes into account units, flats which lower the median price. Plus they use their 'hedonic' index to work out their medians which no-one except RP Data seem to understand. I doubt that the Governor of the reserve bank knows much about it.

  6. Brilliant article, CJG. These words expose ignorance, malfeasance or cognitive dissonance. In whichever case, they are damning. I look forward to more soon!

  7. Re median dwelling price (MDP) vs median house price (MHP). RP Data-Rismark quote MDP for Melbourne at end of Sep 2010 as $465,000. Residex, who also publish medians, quote the MHP at end of Sep 2010 as $592,500. An enormous difference. By the way REIV quotes the MHP at $565,000.

    Let's assume the median household income (MHI) in Melbourne is $72,000 (which would be a fair estimate). Residex' MHP/MHI = 8.2. RP Data's MDP/MHI = 6.5. It is a big difference already.

    Now substitute the Average Household Income (AHI) for MHI - let's use the inflated $95,000 for AHI. RP Data's MDP/AHI = 4.9. By subtle manipulation of the data RP Data has made housing a lot more affordable.

  8. Hi Mic

    I dont think there is any funny business with the median dwelling price data. As I note in my post above, I actually believe Demographia is erroneously using median HOUSE prices. I believe the use of a median DWELLING price (essentialy all types of housing units) is the appropriate numerator in a price to income ratio. Possibly a better approach would be to show both house-price and dwelling price-based ratios, but the only additional info this would show is the difference between house prices and unit prices.

    I think one needs to acknowledge that those that want to use the national median dwelling price as the numerator in P/I ratio are probably using the best number.

    The key to explaining the the difference in the ratio, however, is the difference in incomes (i.e. the demoninator), which varies by ~50%. This is why I focussed on this variable in the above post.


  9. CJG - Fair enough re use of median dwelling price as long as one is consistent when comparing with overseas data. I would still like to know how RP Data-Rismark arrive at their their median house price of ~$500k. [See chart at] when other real estate bodies are quoting $595k and $565k. I assume it is all hidden away in their 'hedonic' algorithm.

  10. I don't have any hope that the Fed/State Gov or RBA will try to do the right thing. Aus has got high home ownership and property investors, so there is enormous (electoral) pressure to do every possible thing to keep this balloon expanding.

    IMHO if the bubble pops quickly, Fed & RBA will release money (QE-Crikey edition) to inflate it and devalue the currency.

    The Market Can Stay Irrational Longer Than You Can Stay Solvent....

  11. Very good analysis - no one will do anything about the 'bubble' until there is a crisis and even then I doubt if it will be a well considered reaction - will probably involve billions of tax payer money. Until then the banks, real estate industry builders, and the politicians will be in denial and will continue to stretch the truth.

  12. Wow! If you have any insights on how increasing public housing can take the heat out of the market, I will be very pleased to let you guest-blog.

  13. CJC - Your contribution to this issue is most helpful.

    As the initiator and co author of the Annual Demographia Survey, I trust the following comments are of assistance.

    Please communicate with my colleague Wendell Cox of Demographia, should you wish to discuss any methodology matters. He would I am sure be pleased to discuss these issues with you.

    What triggered these Surveys back in mid 2004, was my concern the public here in Australia and New Zealand was not getting quality information regarding the state of our housing markets.

    I am particularly hostile to what I term the "mixed measures" where housing affordability and mortgage affordability are thrown in to the same pot and manipulated to suit market conditions. Alun Breward, a Victorian State Economist slammed these on Ockhams Razor back in mid 2004 as I recall.

    Those in the property industry know the mixed measures are technically unsound - but persist in using them, for the free advertising they generate, thanks to a gullible media.

    No one understands them of course. They are not meant to.

    So this is why with the Demographia Surveys we employ the "clean" median multiple. The figures are all there for everyome to see. And we can then quibble and debate them! And thats great and the way it should be.

    More importantly though, the median multiples are a critical foundation for the understanding of structural urban economics. On my website you will find a definition of an affordable urban housing market. It really is just a matter of following the numbers. They speak for themselves.

    Total housing stock value to GDP is also another useful measure. It should not exceed 1.5 times. I have expanded on this on many times. Australia is currently north of 3.3 - possibly well north.

    In rough terms, my view is that there is about $A2.2 trillion of bubble illusory wealth, with in excess of $A400 billion of bubble mortgage debt in the Australian housing market. Near $NZ300 billion and north of $NZ60 billion in the New Zealand market.

    Hugh Pavletich
    Co author - Annual Demographia International Housing Affordability Survey
    New Zealand

  14. The big joke about these 'coastal' properties is that they should be losing value in the face of climate change. There is an abundance of empirical data pointing to the devastation a meter of sea change will cause in major cities, and Australia is already experiencing this annually in areas of Queensland and Victoria. But, why worry, the government will just tax the snot out of the people smart enough to live elsewhere and keep rebuilding so we can do it all again real soon... as is about to happen in Brisbane.

  15. Great Stuff! Keep it up, to all.

    Why not Check out these articles and comments.

    Maybe somewhat simplistic, but maybe a refreshing change. Another why to look at it. If your not impressed, lets hear it.

    Why do we like to make everthing so complicated, even the simple things (I just read). But is'nt it just true.



  16. Very impressed with your insightful commentary. Came here via a link from The Age comments section. Glad I did.

  17. Unfortunately, we are still seeing little signs of mortgage stress. Last March, ratings agency Fitch reported a surprise increase in mortgage delinquencies while the proportion remains small.

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