Despite the dramatic rise in house prices amid the pandemic, most capital cities are still considered affordable for many Australian homebuyers.

A new study by InvestorKit found that house prices in six of the eight capital cities are surprisingly still considered “undervalued”, which indicate positive signs of affordability for prospective buyers.

Perth the most undervalued city

Among all capital cities, Perth’s house prices are the most undervalued at $510,000, 63% cheaper than the maximum price a local household can afford.

According to the study, the large gap in housing affordability is due to Perth's high personal income level and the low median house price - the lowest among capital cities.

While market pressure in Perth is high, sales volumes and listings have started to stabilise, which will slow growth rates for the next year.

However, with the city still experiencing high pressure and a low 10-year price growth of 9%, there could still be opportunity for growth.

Darwin is the second most undervalued capital city, with its median price of $550,000 being 61.3% lower than the affordability level.

If interest rates are to rise, Darwin’s median price would still be 42.8% cheaper.

The study noted that Darwin's high personal income level — the highest among capital cities — and low house prices make it more affordable.

How InvestorKit calculated affordability

InvestorKit analysed the eight capital markets through home loan serviceability, which used the percentage difference between the current median house price and the “affordable house price” to determine whether the market is under or overvalued.

The affordable house price is based on the average local income of a dual-income household and loan affordability of 30% of net income.

The study calculated the maximum house price of an affordable home loan repayment for a 3.5% interest rate and a potential rate hike to 4.5%.

Interestingly, a recent study by the National Housing Finance and Investment Corporation (NHFIC) found that the pandemic has made conditions difficult for many would-be buyers looking to enter the housing market.

However, the NHFIC study indicated that affordability remained relative and dependent on geographical locations.

Other capital cities remain affordable

Brisbane’s median house price is also surprisingly undervalued despite the strong gains over the past year.

The city’s median house price of $603,000 is 29.6% lower than the affordable median price at 3.5% interest rate.

Brisbane will remain undervalued even with a 1% increase in interest rate. Under this scenario, prices would be 14.8% lower than the affordable median price.

Adelaide is also significantly undervalued — its median price at $526,600 is 42.8% lower than the affordable median price.

The study predicts that the sales market pressure in Adelaide could push the city to be a top performer among capital markets.

Meanwhile, the lowest average personal income in Hobart makes its current median price of $595,000 be undervalued by only 18.3%.

If interest rates rise, Hobart’s median house price would only be 5% lower than the affordability threshold.

Sydney, Melbourne’s overvalued markets

According to the study, only Sydney and Melbourne are the only overvalued markets.

Sydney’s house prices are the most overvalued — its median house price is now at $1.11 million.

This makes Sydney 22.3% overvalued, which means house prices are that much higher than the average household can afford.

If home loan interest rates go up by 1%, house prices in Sydney will exceed the affordable level by nearly a third.

In Melbourne, the median house price is at $818,000, which exceeded the affordability level by 2.8% at 3.5% interest rate.

Should interest rates rise to 4.5%, the market would be overvalued by 13.9%, with the maximum affordable house price for an average dual-income household being $795,000.

The ACT is close to being overvalued — while its current median price at $826,000 is still 6.6% lower than the affordability threshold, it could become overvalued by 5.6% if rates are to go up by 100 basis points.

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Photo by @michael75 on Unsplash.