Why Melbourne House Prices Might Be Justified

This morning, an article highlighting Melbourne property prices appeared in The Age. ‘Shocked’ was the best way to describe the feeling of seeing a row of Williamstown shops sell for $11.34 million. Why was this shocking?

The investor who purchased the shops obviously sees that there is money to be made here. Yet investors and developers are not just scooping up commercial properties, but residential ones as well.

Other inner suburbs like South Melbourne are also on investors watchlists. But has this whole property situation gotten out of hand? Are people paying too much for property in Melbourne?

Before we go into any more depth, there’s something we need to be aware of: the Australian property market is not one market.

Saying that Australian property is under or overvalued simply doesn’t make sense. It’s the same for stocks. Just because some believe stocks are overvalued, it doesn’t mean there aren’t any valuable stocks out there, does it?

The same can be said of the Melbourne — or the broader Australian — property market. Of course, there are undervalued houses and apartments out there. You just need to have the dedication to seek out these property gems.

There are many sub-markets within Australian real estate. For example, Melbourne’s property market is different to Sydney’s. And both of these are very different to Adelaide’s property market.

In Melbourne’s case, it comprises of even smaller pockets.

This idea becomes more obvious if you look at property prices from one suburb to the next. Property in Toorak is far more expensive than it is in Craigieburn. And there’s a reason for that. There is higher demand to live in Toorak than there is in Craigieburn.

And the price volatility between the two is different again. This is because both have different drivers of demand. Therefore, it’s more appropriate to say that housing prices in Toorak are overvalued only if demand isn’t there.

This is a big difference to saying that the entire national market is overvalued.

What makes property overvalued?

Just like any asset, if demand is higher than supply, then prices will increase. This is exactly what’s happened with Melbourne property prices. The graph below shows median house prices in Melbourne.

Melbourne House Prices Seasonally Adjusted

Source: REIV

You’ve probably seen this compared to median income. Usually, the first reaction is to be shocked by the difference between housing prices and income. But if demand is the driving force, how can this be a problem?

If housing prices are unaffordable, then why do prices continue to climb? There are obviously speculators in the market…and other factors overinflating some markets. But a large reason why Australian property has performed so well is because of demand. If you want to live close to the CBD, you need to be willing to pay for it.

According to the Australian Bureau of Statistics (ABS), Melbourne had both the largest and the fastest population increase in 2014–15. In that time, Melbourne increased its total population by 91,600 people, or 2.1%.

By 2050, Melbourne is expected to house more than eight million people. This could also make Melbourne the largest capital city in Australia. Mark McCrindle, a social researcher, commented on Melbourne’s rise, stating:

We see this through the world whenever there are cities that get to certain thresholds it’s impossible for cities of many millions to have that one identity or even the one lifestyle so you end up with these groupings within the one metropolis and that’s certainly the way Melbourne is heading,’ Mr McCrindle said.

If Melbourne increases supply, which it already has to some extent, property prices might soon drop to a lower level. But I believe the drop will be less of a crisis, and more a slight correction.

Härje Ronngard,

Junior Analyst, Money Morning

PS: Housing affordability remains a big problem in Australia. Would-be first home owners aren’t finding it any easier to force their way into the market. But Money Morning’s trends specialist, Callum Newman, can show you ways to maximise your potential for getting ahead in the market.

In his report, ‘Australian Real Estate Game Plan’, you’ll learn what really drives property prices. And he lets you in on an insider’s secret that you just can’t miss out on. To get your free copy of Callum’s report, click here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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