Accounting for Longer‐Run Changes in Australian House Prices

• Published date: 01 September 2021
• Author: Glenn Otto
• Date: 01 September 2021
• DOI: http://doi.org/10.1111/1467-8462.12432

The Australian Economic Review, vol. 54, no. 3, pp. 362–374 DOI: 10.1111/1467-8462.12432

Accounting for Longer‐Run Changes in Australian House Prices

Glenn Otto*

Abstract

Miles and Monro (2020) show a large

proportion of the long‐run increase in real

house prices in the United Kingdom is due to

persistent, but unanticipated, declines in the

risk‐free real interest rate. Applying their user

cost method to Australia indicates longer‐run

growth in real house prices is better ac-

counted for by changes in the real mortgage

rate than in the risk‐free rate, especially

during the period 2004–2019. Declines in real

mortgage rates during the COVID‐19 pan-

demic are consistent with long‐run growth in

house prices in the range of 10–50 per cent.

1. Introduction

Over the last three decades the real price of

housing in Australia has shown a generally

persistent upward trend. Figure 1 shows the

Australian Bureau of Statistics (ABS) price

index for established houses in the eight

capital cities—since the mid‐1980s—deflated

by the consumer price index (CPI).1 During

the period 1987–2020 house prices grew at a

real rate of 3.7 per cent per annum, resulting

in a total increase by a factor of about 3.

What can explain the persistent rise in the

relative price of Australian housing? In recent

work for the United Kingdom, Miles and

Monro (2020) decompose long‐run changes in

aggregate house prices using the equilibrium

condition for housing markets that equates the

rental yield on housing to its user cost

(Poterba 1984). They find the increase in

UK house prices during the period 1985–2018

can be largely accounted for by persistent, but

unanticipated, falls in the real risk‐free interest

rate. In this paper I use Miles and Monro's

basic (2020) framework to examine the extent

to which changes in real interest rates account

for the longer‐term trends in Australian house

prices.

The user cost framework and the related

present value model have been widely used to

study housing markets in Australia, although

the primary focus of previous studies has not

been to account for decade‐level changes in

real house prices. I begin by outlining the user

cost framework and its implications, and then

review its applications to modelling house

prices in Australia. In Sections 3 and 4 I report

* School of Economics, UNSW, Sydney, 2052, Australia.

email: <g.otto@unsw.edu.au>.

© 2021 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research,

Faculty of Business and Economics

Published by John Wiley & Sons Australia, Ltd