A report prepared by the International Monetary Fund has warned that Australian property is among the most overvalued in the developed world, behind only Ireland, the Netherlands and Britain in terms of vulnerability.

While few local commentators have raised the prospect of a serious housing recession the likes of which is currently sweeping the United States, on many bases, the Australian housing sector appears to be more over-priced that the US (which has seen prices drop by more than 22 percent in parts of California and Florida). Last week, the Standard & Poor’s/Case-Shiller index of US home prices slumped by a staggering 10.7 percent in the year to January (with Las Vegas reporting a 19.3 percent drop).

So far, Australian property values have remained largely immune from any fallout (with only Western Sydney experience significant value drops), despite appearing to be relatively more expensive than our trans-Pacific counterpart. As Alan Kohler noted in Business Spectator on 26 January:

The Australian median house price is now $A432,767, up 12 per cent in the past year. The head of property research there, Louis Christopher, is predicting another 12 per cent increase this year.

According to the zillow.com national database, the media US house price is now $US244,000 ($A277,000), 5.7 per cent less than it was a year ago and just two-thirds of the median in Australia.

While respective incomes in Australian and the US are similar, Australian houses cost almost double those in the US. Australian home buyers seem to be living in some sort of fool’s paradise if they think that even the affluent Sydney, Perth and Melbourne markets are indestructible.

While Australia doesn’t have the sub-prime lending crisis that has engulfed the US, Australia has its own “lo-doc” sector, which includes originators like Liberty Financial, Bluestone and Mobius. Mobius, a subsidiary of Allco, last year reported a technical default rate of more than 15 percent (prior to the spate of interest rate rises). Unsurprisingly on 29 February, Allco announced that Mobius will no longer accept mortgage applications and would attempt to offload its assets.

Warren Buffett’s comments in his 2007 Letter to Shareholders appear to be as much a forward prediction in Australia, as they were a reflection in the US. Buffett noted that:

Americans came to believe that house prices would forever rise. That conviction made a borrower’s income and cash income seem unimportant to lenders, who shoveled out money, confident that HPA – house price appreciation – would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief. As house prices fall, a huge amount of financial folly is being exposed.

On the simple yield basis, it is difficult to justify the prices being paid in the wealthier Perth, Melbourne, Darwin and Sydney suburbs. For example, a typical three bedroom house in Melbourne’s leafy Hawthorn will yield an investor around 2%. With variable lending rates at more than 9%, purchasers require a significant capital gain to justify investing in real property over say, fixed interest. Meanwhile, clearance rates in Sydney are already hovering around the low 50% mark, while the Melbourne clearance rate is well down from 80% last year to around 60% now, indicating that demand is significantly down. This reduces the “fear factor” – that is, the apparent necessity for people to buy property so as not to “miss out”, which irrationally forced house prices well above their intrinsic value.

Australia has never encountered a serious drop in residential property (even during the recession of the early 1990s, property values generally went sideways rather than dropped). However, the precedents of the US and Japan (which saw property values drop as much as 65 percent) could mean that a lot of highly leveraged homeowners may see their equity value diminish substantially in the coming years.