Sydney’s property prices relative to residents’ earning power makes for startling reading, but how will this affect the market?

 After being bandied about as the golden child of 2011’s property markets, Sydney has more recently been acting the ugly stepchild – and no one wants to pay for the babysitting.

The story of its property markets of late has been one of mounting affordability concerns, as the gap widens between property prices and average incomes. This has prompted a situation where economists fear that a correction may be underway as high prices push buyers out of the market.

“[The] issue comes back to affordability,” says Residex CEO John Edwards. “There remains a housing need and shortage but house and land packages are not affordable.”

Residex estimates that it now takes around 52% of after-tax income to repay a median-valued house in Sydney, assuming a 20% deposit was put down. Edwards says that this may be partly the reason for his company’s January statistics pointing to a drop in Sydney median house prices. Values fell by -1.18% over the month, -1.31% over the quarter and -3.45% over the year.

By comparison, the unit market has fared better and Edwards believes that affordability could be playing a part once more. Though January unit prices saw negative growth with a monthly median price change of -0.68%, the annual growth remains positive at 2.11%.

“I am concerned that the public will not recognise the potential issue that may be developing in Sydney’s house and land market due to affordability issues,” says Edwards. “The result may be that people simply read the press and believe they should be investing in houses because they are given the impression that the worst is over.”

Edwards advises investors to compare the performance of houses and units separately, rather than falling into the trap of looking at the entire market as two parts of a whole. “Housing markets and unit markets grow at different rates, during different periods of time and I cannot stress enough the importance of reviewing these markets separately. While one market produces good growth, the other may be in decline.”

He adds that property investors who plan to target Sydney would do well to avoid houses and focus on units. “At this stage, I think it would be sensible to take care and avoid the house and land market unless you are buying at bargain basement prices. The best investment class in Sydney property at this point in time, in my opinion, is established, older-style units.”

Sydney comes third

The severity of Sydney’s affordability problems was recently highlighted in a global study of house prices. According to the 2012 Demographia International Housing Affordability Survey, Sydney remains one of the world’s least affordable property markets, ranking third on the list of most costly cities.

The survey ranked markets based upon the multiple of the median house price divided by gross annual median household income. Calculating affordability this way, the Demographia study estimated that median house prices in Sydney are 9.2 times the average household income.

Although Hong Kong and Vancouver ranked higher on its list, Demographia measures still slammed Sydney as “severely unaffordable”, and claimed that in general Australia has the “most pervasive housing affordability problem” given its abundant land supply.

West is best?

As the rest of the city faces affordability problems, SQM Research forecasts Western Sydney will have a great year. The research firm’s Western Sydney Regional Report, released at the beginning of the year, expects Sydney’s west to outperform most Australian regions over 2012 on the back of tight vacancy rates, strong population growth compared to broader Sydney, and good rental yields.

“We have quite a high conviction that Sydney’s west is likely to outperform most regions throughout the country for the next three years. We take this position based on the view that there is an actual genuine shortage of real estate in the region,” says SQM managing director Louis Christopher.

Christopher adds that this prediction can be demonstrated by the supremely tight vacancy rates in the region, which hints that an oversupply of dwellings is unlikely. “We see no signs of an oversupply in terms of dwelling construction [and] also note the [area’s] relative affordability.”