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Housing overvalued like most other assets

AAP logoAAP 6/10/2016 Garry Shilson-Josling, Economist

Housing is overvalued, or at least very expensive, depending on which measure you use. The problem is, so is just about everything else.

And it's likely to stay that way until inflation rises around the world.

Shares in most major economies are at or near their highest valuations relative to expected earnings for a decade and a half.

Bond yields are almost comically low - around a third of government bonds around the world have a negative yield, meaning you have to pay the government to mind your money.

The yield on cash deposits is low in developed economies, often below the inflation rate.

Looking at the big picture, there are two reasons for al of this.

Central banks have pushed interest rates down in a decade-long attempt to lift the global economy out of the mire it's been stuck in since the financial crisis nearly a decade ago.

The other reason is chronically low inflation, stemming in part from this bout of below-potential growth, and in part from a range of structural factors, including relentless competitive pressure from China.

Low inflation means interest rates have to be cut even further by central banks to have a positive economic impact.

And those extra-low interest rates are factored into asset valuations.

That's because any asset can be seen as the right to receive two things.

One is a flow of income payments - dividends from shares, rent from housing or interest payments from bonds.

The other is the payment for that asset when it's sold or, in the case of a bond, repaid.

But that future stream of cash flows has to be discounted, because money you have now can be invested, resulting in a higher future value.

So future income has to be discounted to bring it back to its equivalent present value.

And as the interest rate factored into that discounting calculation falls, the present value of future income rises.

In other words, low interest rates mean investors will typically pay more to receive a given stream of income from holding an asset, boosting the asset's market value.

And you can see that in the housing market.

The latest report from CoreLogic on home values estimates the average rental yield on Australian residential property to be 3.3 per cent.

That's the lowest in the 20-year history of CoreLogic's data.

The Real Estate Institute of Australia's figures, compiled on a different basis, show rental yields are the lowest for at least 34 years and, given how high they were in 1982, probably much longer than that.

There are temporary factors boosting demand and pushing housing prices up - and yields down - like population pressures, restrictions on land supply, and unusually low interest rates.

But there's no doubt that the global climate of low inflation and ultra-low interest rates is supporting asset prices all around the world, including Australia's housing market.

And that in turn suggests a major risk factor for housing investors will be any concrete signs of the lift in inflation that central banks have been trying so hard to generate.

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