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IJHMA
12,4
746
Received 19 October 2018
Revised 27 November 2018
Accepted 5 December 2018
International Journal of Housing
Markets and Analysis
Vol. 12 No. 4, 2019
pp. 746-762
© Emerald Publishing Limited
1753-8270
DOI 10.1108/IJHMA-10-2018-0082
Modelling housing prices and
market fundamentals: evidence
from the Sydney housing market
Md Abdullah Al-Masum
School of Business, Western Sydney University, Penrith,
New South Wales, Australia, and
Chyi Lin Lee
School of Business, Western Sydney Univeristy, Parramatta,
New South Wales, Australia
Abstract
Purpose – Housing prices in Sydney have increased rapidly in the past three decades. This leads to a debate
of whether Sydney housing prices have departed from macroeconomic fundamentals. However, little research
has been devoted to this area. Therefore, this study aims to fill this gap by examining the long-run association
between housing prices and market fundamentals. Further, it also examines the long-run determinants of
housing prices in Greater Sydney.
Design/methodology/approach – The analysis of this study involves two stages. The first stage is to
estimate the presence of long-run relationship between housing prices and market fundamentals with the
Johansen and Juselius Cointegration test. Thereafter, the determinants of housing prices in Greater Sydney is
assessed by using a vector error correction model.
Findings – The empirical results show that Sydney housing prices are cointegrated with market
fundamentals in the long run. In addition, there is evidence to suggest that market fundamentals such as
gross disposable income, housing supply, unemployment rate and gross domestic product are the key long-
run determinants of Sydney housing prices, reflecting that Sydney housing prices, in general, can be
explained by market fundamentals in the long run.
Research limitations/implications – The findings enable more informed and practical policy and
investment decision-making regarding the relation between housing prices and market fundamentals.
Originality/value – This paper is the first study to offer empirical evidence of the degree to which the
behaviour of housing prices can be explained by market fundamentals, from a capital city instead of at a
national level, using a relatively disaggregated dataset of housing price series for Greater Sydney.
Keywords Australia, Housing prices
Paper type Research paper
1. Introduction
Housing is the second most significant economic component in Australia (REIA, 2015).
Specifically, housing is the single largest asset for Australian households’ portfolio and
contributed approximately two-thirds of the Australian household assets (Australian
Bureau of Statistics, 2017a, 2017b, 2017c); thereby, the movement of house price would have
This paper is written based on the findings of the Master Thesis of Md Abdullah Al-Masum entitled
of “Modeling Housing Market Fundamentals: Evidence from the Sydney Housing Market” at
Western Sydney University. The authors would like to acknowledge the support from Western
Sydney University.
a profound implication on the wealth of Australian households (Lee, 2008, 2017). Therefore, Housing prices
an enhanced understanding of the movement of house price is critical. and market
Importantly, housing price in Sydney had increased significantly over 2012-2016.
Specifically, it had increased by 70.3 per cent, which was significantly higher than the
fundamentals
appreciation rate of 40 per cent for Melbourne (the second largest Australian housing market)
and other Australian capital cities. Indeed, Australia, particularly Sydney, has been
encountering severe house price contagion risk, and that resulted in a deterotation of housing
affordability (Holzhey and Skoczek, 2016). In 2017, housing in Sydney had reached to a severely
747
unaffordable stage. Moreover, Sydney was ranked as the second least affordable city globally
with a medium multiplier housing price to income of 6.1 (Cox and Pavletich, 2017).
Consequently, the issue of housing affordability in Sydney has become one of the major
concerns of policymakers and homebuyers, especially first home buyers (Lee and Reed, 2014a).
Given housing is a critical component of an economy, a rapid growth of housing prices
leads to a concern of housing bubble that would have a significant impact on the economy
(Stevenson, 2008). A number of commentators argued that housing price in Sydney has
grown too rapidly. Rapid price rises in the Sydney housing market had departed from
market fundamentals and emerged as indicative of speculative bubbles (Martin, 2017;
Burwick, 2016; Chung and Craze, 2016; Powell, 2015). On the other hand, numerous property
professionals, the leading Australian banks and the Reserve Bank of Australia (RBA) have
argued that there is no clear indication of an overvaluation in the Sydney housing market
(Real Estate Institute of Australia [REIA], 2015; Fox and Tulip, 2014). As such, it remains
unclear to the extent of which market fundamentals are quantitatively important influences
on Sydney housing prices.
Theoretically, housing price is determined through a joint consideration of supply and
demand (DiPasquale and Wheaton, 1994). In other words, housing prices should be
explained by market fundamentals in the long run. Hence, a long-term equilibrium
relationship between asset pricing and relevant macroeconomic variables should be
documented (Chen et al., 1986). In addition, the departure of housing prices from market
fundamentals can be interpreted as the existence of housing bubbles. At this juncture, it is
critical to ascertain the validity of the above theoretical relationship. While many studies
have examined the way housing prices interacts with market fundamentals at the
aggregated country level, much less attention has been paid to the city level by recognising
the differences among cities. Moreover, mixed results have been documented by previous
studies, indicating that many issues surrounding housing price and market fundamentals
have not been fully investigated.
The aim of the study is to explore how market fundamentals interact with house price in
a long run with a more disaggregated data by using housing price series for Greater Sydney.
More specifically, this study addresses the following research questions:

RQ1. Are fundamental factors cointegrated with housing prices in Greater Sydney in a
long run?

RQ2. What are the key fundamental factors to explain housing price in Greater Sydney
in the long run?
This study focusses on Greater Sydney because of several reasons. First, Greater Sydney is
an interesting case of study with respect to a strong house price appreciation rate that has
been observed in the past 30 years[1]. Holzhey and Skoczek (2016) have shown that there
was an increase of 45 per cent of Sydney house price since mid-2012 to 2016. Additionally, it
IJHMA is noteworthy to find that Sydney house price has increased more than double in the past 30
12,4 years (Housing NSW, 2017). The rapid house price appreciation rate resulted in a
deterioration of housing affordability. As discussed earlier, Sydney is the second least
affordable city in the world with a median multiplier of 6.1. Importantly, the growth in
median household income over 2001-2015 in Sydney was only 13.1 per cent, whereas
Melbourne, Brisbane, Adelaide and Perth recorded increases of 25.3, 34.8, 32.6 and 52.4 per
748 cent, respectively (Wilkins, 2015). Thus, income growth in Sydney is lower than other
capital cities. On the other hand, house price growth of Sydney had increased sharply over
the same period, thereby, it is rational to find that Sydney is the least affordable Australian
city compared to other metropolitan areas. Second, Greater Sydney is the largest capital city
in Australia. As of September 2017, more than five million people live in Greater Sydney
(Australian Bureau of Statistics, 2017a). Furthermore, Greater Sydney accounts for almost
78 per cent increase in New South Wales population in 2015-2016 (Wade, 2017). This high
population growth rate did create a huge demand for housing in the Greater Sydney.
Therefore, Greater Sydney appears as an important case study to scrutinise the long-run
linkages between housing prices and market fundamentals.
The study contributes to the housing literature in a number of ways. First, unlike many
previous studies, this study examines the degree to which the behaviour of housing prices
can be explained by market fundamentals from a capital city perspective instead of at a
national level. Importantly this study expands upon the limited literature to have considered
the disparities among different capital cities. As discussed by Akimov, Stevenson and
Young (2014), different housing markets have different cycles, implying that a
disaggregated analysis would offer a fuller insight into the housing price dynamics. This is
particularly critical in the Sydney context. Unlike other Australian housing markets
(e.g. Perth and Adelaide), housing price in Sydney has proliferated significantly in recent
years; thus, a dedicated study of the Sydney housing market offers an enhanced
understanding of the linkages between market fundamentals and housing prices from a
micro perspective. To the extent that economic fundamentals do provide a good explanation
for housing prices would offer further insights into the Sydney housing market. This allows
policymakers to make an informed decision in relation to whether a tighter monetary policy
is required. Second, although Stevenson (2008) demostrated the superior ability of vector
error correction model (VECM) in modelling the linkages between housing prices and
market fundamentals, few studies have used this model to assess the linkages between
market fundamentals and the Sydney housing market. The only exception is Abelson et al.
(2005) with a relatively old dataset at an aggregated level (Australia). This study, therefore,
is an extension of Abelson et al. (2005) in which it coveres the study period of 1991-2016. The
study period includes the major economic events such as the global financial crisis and
the boom of foreign housing investments (Rogers et al., 2015). The study contributes to the
literature by offering more recent and up-dated results regarding the long-run linkages
between housing prices and market fundamentals in Sydney using the VECM.
The remainder of this paper is organised as follows. Section 2 reviews the related studies
on housing prices and market fundamentals. Section 3 discussess data and the methodology.
Section 4 reports and discussess empiricial results. Finally, Section 5 concludes the paper.

2. Literature review
The Australian housing market has witnessed a substantial increase in real house prices.
This leads to a question of the degree to which the housing price appreciation rate reflects
market fundamentals. In fact, the rapid housing price growth could be attributed to price
asymmetry. Specifically, households anticipate a potential house price growth and disagree
on trading at a discount to circumvent the risk of negative equity return (Stevenson, 2008; Housing prices
Stiglitz, 1990). This tendency creates a deviation from fundamentally justified prices and and market
generates a housing price movement asymmetry (Case and Shiller, 2003; Glaeser et al., 2005).
To assess the extent of the potential overpricing of a housing market, it is essential to
fundamentals
recognize the fundamental value of housing as it is exclusively determined by market
fundamentals (Fry et al., 2010). A variety of models have been used by extensive studies to
understand the behaviour of house prices. A majority of these studies focus on whether
market prices are in line with fundamental values with numerous methodologies (Bourassa 749
et al., 2001; Himmelberg et al., 2005; Stiglitz, 1990).
Peng et al. (2016) examined the effect of fundamental and non-fundamental factors
through a dynamic panel model on house prices over eight capital cities in Australia. They
found that both factors, namely, the value of new residential buildings and overall crime
rate, relatively substantial effect on house prices. Costello et al. (2015) found that the impact
of interest rate shock due to a tight monetary policy is almost neutral in changing house
prices on a national level, but they observed a significant house price asymmetry at the
capital city level. Akimov et al. (2015) investigated the movement of house price and
observed price deviation between original and observed prices of the cities in Australia.
Kohler and Van Der Merwe (2015) examined the factors influencing the long-term growth of
housing price in Australia for the past three decades. They found that population growth
along with the financial deregulation, as well as a low but stable inflation, may explain the
fundamental house price. Lee and Reed (2014b) offered an insight into the pattern of
fundamental housing price shifts through the determinants of permanent and transitory
components. Fox and Tulip (2014) assessed the overvaluation of Australian housing prices
by comparing housing user costs to rental yield. Abelson et al. (2013) investigated the
association between house prices and housing density and transport infrastructure (rail and
bus transit hub) as fundamentals. They concluded that there is absolutely no discrete
influence of housing density and access to a sub-centre on house prices. Liu and London
(2013) examined the ripple effect between housing supply and monetary policy during the
global economic turmoil. They related the significance of population increment as the key
fundamental factor contributes to housing supply shortage. Leung and Tsang (2013) stated
that commodity prices can influence house prices directly. Costello et al. (2011) concluded
that the house prices in New South Wales (NSW) are overvalued because of some factors
and macroeconomic factors can warrant the above measures efficiently. Fry et al. (2010)
scrutinised whether house prices in Australia are overvalued through a structural vector
autoregression model. The study concludes little support that monetary policy contributes
to the observed overvaluation of real house prices. Lind (2009) suggested that an
amalgamation of factors namely, interest rate costs about household incomes, the elasticity
of supply, price expectations and credit conditions do explain housing fundamental values.
Stevenson (2008) assessed market fundamentals and their impacts during the period of
extreme price shifts of housing market with an error correction model. However, he found
that employment, income and demographic changes are not sufficient to explain the shift in
house prices.
Apart from the above fundamental factors, housing price movements are also influenced
by speculative behaviour (Scheinkman and Xiong, 2003). Speculative behaviour could be
explained by the expectations of further capital appreciation (Fox and Tulip, 2014).
Importantly, homebuyers or investors rely heavily on the recent historical house prices in
their decision-making (Poterba et al., 1991). Hatzvi and Otto (2008) argued that there is an
existence of speculative bubbles if home buyers or investors purchase a house with a
premium that is significantly higher than the fundamental value as they believe that the
IJHMA resale price of their investment will be high in the future. Black et al. (2006) concentrate on
12,4 how real house price interacted with fundamental house values in the UK. They found that
both explosive and intrinsic bubbles constitute the evidence of rationality. Hui and Yue
(2006) investigated housing price bubbles in Beijing and Shanghai with considering market
fundamentals such as GDP, stock price index and urban household disposable income or
consumption expenditure. Abelson et al. (2005) find fundamentals factors like real
750 disposable income and CPI are positively involved in estimating property prices in the long
and shortrun. Conversely, in the short run, housing price estimation is heavily influenced by
the combination of unemployment rate, real mortgage rates, equity prices and housing
supply. This study finds that there are significant lags in an adjustment in determining
actual house price to reach an equilibrium condition. Kenny (1999); Malpezzi (1999) and
McQuinn (2004) bring a new approach –VECM – to the valuation of housing price. Kenny
(1999) discovers that a long-run cointegration association exists in housing stock, aggregate
income and interest rates. Moreover, they found that the significance of scarcity of land
supply would be the primary cause to trigger up housing price in the long-run equilibrium.
In summary, several studies have been devoted to model fundamental house value,
whereas mixed results have been documented regarding the extent that economic variables
do explaining the behavoiur of housing price or the existance of housing bubbles. This can
be attributed to the used methodologies. As such, Stevenson (2008) compared the ability of
various models in estimating the fundamental value of house price and found that VECM
offers the superior ability. Ashworth and Parker (1997) and Drake (1993) probably are the
pioneering studies to apply a VECM in modelling housing price. The purpose of the
application of VECM is to model fundamental housing values and the impact of independent
variables. One of the advantages of the VECM is that it can be applied when both variables
and parameters are nonstationary but cointegrated (Hill et al., 2001). Importantly, the VECM
allows the dependent variable to be considered stationary when the random error is purely
random and leads to a short-term departure from the cointegrating equilibrium path,
depending on the exit from the long-run equilibrium in the previous period. Finally, there is
a tendency to correct back towards the equilibrium (Hill et al., 2001).
Despite the advantages of this model, no study has considered the use of VECM, an
advanced application of a standard inverted demand model, to examine the price movement
of the housing market in Greater Sydney. Importantly, no study has been placed to model
housing price of Greater Sydney despite the rapid housing price appreciation in recent years
and the onset of the global financial crisis.

3. Data and methodology

3.1 Data
The study used the quarterly data series that were collected from the Australian Bureau of
Statistics (ABS), Housing NSW and RBA. Quarterly median house sales price (MHSP) was
collected from Housing NSW (2017). Following Abelson et al. (2005); Stevenson (2008) and
Lind (2009), market fundamental variables include gross domestic product (GDP),
household’s gross disposable income (GDI), total housing supply (HS), population (POP),
lending rate (INTEREST) and unemployment rate (UNEMP)[2]. GDP reflects the economic
performance of a country. The data were obtained from the ABS (cat. no. 5,206.0)[3].
Household GDI was collected from the ABS (cat. no. 5,206.0) (Australian Bureau of
Statistics, 2017b). Housing stock or supply (HS) is the total number of dwellings in both
private and public sectors. The data were sourced from the ABS (cat. No. 8,731) (Australian
Bureau of Statistics, 2017c). Total population data were collected from the ABS (cat. no.
3,101.0) (Australian Bureau of Statistics, 2017a), whereas lending rate (INTEREST) for
housing loan was sourced from the RBA. The unemployment rate (UNEMP) was obtained Housing prices
from the ABS (cat. no. 6,202.0) (Australian Bureau of Statistics, 2017d). and market
The sample observation period commences from the first quarter 1991 to the fourth
quarter 2016, consisting of 104 observations for all variables, namely, MHSP, GDP, GDI, HS,
fundamentals
POP, INTEREST and UNEMP. This study commences from 1991: Q1 as the data, especially
median house price, is only available from the first quarter in 1991. The trend of median
house price in Sydney is depicted in Figure 1. Specifically, there is an upward trend for the
median house prices over the study period. The summary statistics are depicted in Table I. 751

3.2 Methodology
The section comprises two stages. First, the time-series properties of the series were
estimated with a number of unit root tests. Subsequently, a cointegration test and a VECM
were performed to gauge the long-run relationship between house prices and market
fundamentals.
3.2.1 Unit root tests. Following Lee and Lee (2014), this study applies three different types
of unit root tests, namely, augmented Dickey-Fuller (ADF) test (Dickey and Fuller, 1979, 1981),
Phillips-Perron test (PP) (Phillips and Perron, 1988) and Kwiatkowski–Phillips–Schmidt–Shin

1,000,000
800,000
600,000
400,000
200,000 MHSP

0
Figure 1.
1-Sep-94

1-Sep-08

1-Sep-15
1-May-92

1-Sep-01

1-May-06

1-May-13
1-Mar-91

1-May-99
1-Jan-97
1-Mar-98

1-Jan-04
1-Jul-93

1-Nov-95

1-Jul-00

1-Nov-02

1-Mar-05

1-Jul-07

1-Jan-11
1-Nov-09

1-Mar-12

1-Jul-14

1-Nov-16

Yearly median house

price of Greater
Sydney:
Q1 1991-Q4 2016
Source: Housing NSW, median house sales prices since 1991-2016

Variables MHSP POP HS GDI UNEMP INTEREST GDP

Mean 12.77 15.72 8.65 11.87 1.83 2.02 12.29

Median 12.94 15.71 8.70 11.84 1.75 1.99 12.28
Maximum 13.63 15.87 9.08 12.61 2.43 2.67 13.02
Minimum 11.92 15.59 8.05 11.11 1.50 1.66 11.51
SD 0.49 0.08 0.26 0.46 0.25 0.22 0.46
Skewness
0.18 0.21
0.37 0.05 0.89 0.73 0.05
Kurtosis 1.86 1.95 2.00 1.63 2.71 3.10 1.63
Jarque-Bera 6.24 5.55 6.74 8.20 14.13 9.18 8.20
Probability 0.04 0.06 0.03 0.02 0.00 0.01 0.02
Sum 1,328 1,634 900 1,234 191 210 1,278
Sum sq. dev. 24.58 0.66 6.74 22.18 6.25 4.85 22.20
Observations 104 104 104 104 104 104 104 Tables I.
Notes: MHSP is median house sales price; GDP is a gross domestic product, GDI is gross disposable Descriptive statistics
income; HS is housing supply; POP is estimated residential population; INTEREST is the lending rate for of variables:
homeowner and occupier and UNEMP is unemployment rate Q1 1991-Q4 2016
IJHMA test (KPSS) (Kwiatkowski et al., 1992), to examine the time-series properties of each variable
12,4 (such as GDP, GDI, HS, POP, INTEREST and UNEMP). First, we examine whether these
variables are stationary in levels and then the first difference. If these variables are stationary
at the first difference that is I (1), these variables could be potentially integrated in the same
order (Hui and Yue, 2006).
3.2.2 Cointegration test and vector error correction model. The long-run equilibrium
752 relationship between house prices and market fundamentals was assessed with a
cointegration test and a VECM. Following Lee et al. (2017), the Johansen and Juselius
Ccointegration test was used to identify the existence of cointegration between housing price
and market fundamentals over a long run. After that, the VECM was used to estimate their
long-run equilibrium relationship. Explicitly, the VECM exhibits the last-periods deviation
from a long-run equilibrium and estimates how quickly the dependent variable will return to
the equilibrium point when the changes happen in independent variables. Additionally, it
allows a linear combination of two nonstationary time series, when two-time series data of
linear combination is I (0) and then the whole series is said to be cointegrated even if the
individual series of the data is I (I) (Stevenson and Young, 2014). At here, the data must be
the first difference data to avoid potential misspecification bias in a cointegration test
(Mukherjee and Naka, 1995; Stevenson and Young, 2014). The VECM for the study is
displayed as follow:

pht ¼ a1 þ b 1 GDIt þ g 1 HSt þ l 1 POPt þ x 1 INTERESTt þ z 1 UNEMPt þ h 1 GDPt þ « t

(1)

where Pt is housing price of Greater Sydney, GDIt relates household disposable income, HSt
is total housing supply in Sydney, POPt represents total population, INTERESTt is lending
rate to standard housing loans, UNEMPt is unemployment rate and GDPt is GDP of
Australia.
Short-term changes are driven by changes in the explanatory variables in the long-run
relationship and by adjustments to previous disequilibrium in the long-run relationship.
Therefore, the short run linkages can be estimated as follows:

DPt h ¼ a1 þ b 1 DGDIt þ b 2 DHSt þ b 3 DPOPt þ b 4 DINTERESTt þ b 5 D UNEMPt

þ b 6 DGDPt þ d 1 ect
1 þ « t :
(2)

where and ect
1 is the error correction term. This indicates the degree of adjustment.

4. Results and discussion

4.1 Correlation analysis
Table II presents the correlation matrix in which it is the reflection of the coefficient of
multiple correlations among variables. The results suggest that there is a significant
positive correlation between MHSP and POP, GDI and GDP at around 97 per cent. On the
other hand, MHSP is strongly and negatively correlated with INTEREST (
0.75) and
UNEMP (
0.84). Additionally, a low negative correlation coefficient between HS and MHSP
(
0.42) has also been observed. Strong correlation between these variables also implies that
these variables could be co-integrated in the long run, while the preliminary results should
be formally assessed.
4.2 Unit root tests Housing prices
To avoid the possible spurious results from the non-stationary variables, the study and market
uses ADF, KPSS and PP tests to examine the time-series properties of each series. The
null hypothesis (H0) of ADF and PP tests is that the presence of a unit root, whereas
fundamentals
KPSS reverses the H0. The results of ADF, PP and KPSS unit root tests are reported
in Table III.
As can be seen from Table III, the results demonstrate that all variables are stationary at
the first difference. Specifically, the ADF and PP statistics are statistically significant at 5 753
per cent level at the first difference, suggesting that all of these variables are I (1).
Comparable results are found from the KPSS test in which all variables are statistically
insignificant. As discussed earlier, H0 of the KPSS test is that a series does not have a unit
root. Therefore, the documented results suggest that the series are stationary at the first
difference. The only exception is POP in the ADF test, while both KPSS and PP tests have
demonstrated that this variable is stationary at the first difference. This suggests that this
variable is I (1). Overall, the above unit root table shows that all the variables have a unit
root. In other words, these variables are stationary at the first difference. Therefore, all
variables are I (1), suggesting that this is reasonable to conduct a cointegration test and the
VECM.

Variables MHSP POP HS GDI UNEMP INTEREST GDP

MHSP 1.000
POP 0.973 1.000
HS
0.417
0.396 1.000
GDI 0.968 0.988
0.484 1.000
UNEMP
0.836
0.760 0.575
0.783 1.000
INTEREST
0.751
0.728 0.036
0.679 0.568 1.000
GDP 0.973 0.985
0.505 0.997
0.810
0.682 1.000
Table II.
Note: The above table is the reflection of the coefficient of multiple correlations or the linear dependence Correlation among
among variables variables

Level series Differenced series

Variables ADF KPSS PP ADF KPSS PP

GDP
1.10 1.14***
0.57
04.02*** 0.09
34.33***

GDI
0.32 1.14***
0.30
03.23** 0.10
18.11***
HS
1.69 0.53**
2.19
10.34*** 0.10
10.02***
POP 1.32 1.14*** 2.51 (
2.04) 0.48
07.70***
INTEREST
1.10 0.79***
2.73
06.44*** 0.12
05.95***
UNEMP
1.20 0.94***
1.65
15.96*** 0.06
15.56***

Notes: The table details the unit root test statistics on the level series and first-differenced data series
(Elliot-Rothenberg-Stock adaptation of the ADF test, PP test and KPSS test) of each of the variables in the
empirical discussion; *, ** and *** indicates significant at 10, 5 and 1 per cent levels, respectively. The Table III.
figure within parenthesis describes not significant at any levels and overall lag length four determined by Unit root tests (ADF,
LR, FPE, AIC and HQ PP and KPSS)
IJHMA 4.3 Cointegration test
12,4 To assess the unrestricted cointegration rank among these variables, this study applies the
Johansen test of cointegration[4]. The results are depicted in Table IV. The trace and
maximum eigenvalue tests conclude at least three cointegrating equations (vectors) in the
full sample period at the 0.05 level. Specifically, the trace test rejects the H0 of r # 2 in
favour of at most three (H0), suggesting that there are three cointegration relationships exist
754 in the full sample of observations.
Comparable evidence is found by the Maximum Eigenvalue. As at the rank two, both
trace and max-eigen produce a similar amount of cointegrating relationships showing
p-value is significant at the 5 per cent level. In brief, it can be concluded that three
cointegration relationships exists among these variables in the long run. In other words,
there is a long-run association among these variables, indicating that fundamental
macroeconomic variables and housing prices move together in the long-term.
Overall, the Johansen cointegration test asserts that market fundamentals and housing
price are cointegrated and move together in the long run. Although, the results from the
cointegration test indicate causality exists between data series in the long run, but it fails to
show the direction of the causal relations. A VECM, therefore, was undertaken as it can
show the causal relations among variables.

4.4 Long-run relationship between market fundamentals and housing prices

Table V shows the long-run causality relations among market fundamentals and housing
prices. Specifically, the results of the VECM are reported in Table V.
As can be seen from Table V, four long-run determinants of housing prices have been
identified. Importantly, most of these variables have anticipated signs. Specifically, we found
that, as hypothesized, the association between MHSP and GDI is positive and statistically
significant at 1 per cent in the long run. This suggests that GDI is the key determinant in
which one unit of increase in GDI would lead to 7.54 units of median house price in Greater
Sydney, reflecting the economic significance of gross disposable income. Compared results
are found by Abelson et al. (2005) and Stevenson (2008) with the aggregated data set.
Another important observation is that the relation between MHSP and HS. The
coefficient of housing supply is negative, as hypothesized, and statistically significant at 1
per cent. The result is consistent with the previously documented results in Ireland
(Stevenson, 2008; Stevenson and Young, 2014) and Australia (Abelson et al., 2005).

Hypothesized Trace Max-eigen

no. of CE(s) statistic statistics

None 194.197*** 65.147**

At most 1 129.050*** 45.851**
At most 2 83.199** 38.079**
At most 3 45.1201 17.799
At most 4 27.321 17.197
At most 5 10.124 9.356
At most 6 0.7682 0.768

Notes: Both trace and max-eigen test ensure at least three cointegrating relationships significant at the 0.05
Table IV. (Mackinnon-Haug-Michelis [1999] p-value) level. The test statistics of trace and max-eigen are based without a
Tests for the linear trend ( m = 0). The critical values (CV) are given at 5 per cent level. The H0 says at most r (order of
cointegration cointegration) cointegrating vectors; *, ** and *** indicates significant at 10, 5 and 1 per cent levels, respectively
Variables Results
Housing prices
and market
Gross disposable income (GDI) Coefficient 7.542 fundamentals
t-statistic ( 2.750) ***
Housing supply (HS) Coefficient
1.291
t-statistic (
3.913) ***
Population (POP) Coefficient 3.929
t-statistic (0.590) 755
Interest (INTEREST) Coefficient
0.313
t-statistic (
1.148)
Unemployment rate (UNEMP) Coefficient
0.824
t-statistic (
2.536) ***
Gross domestic dProduct (GDP) Coefficient
10.268
t-statistic (
4.551) ***
Constant (c)
24.524
R2 0.445
Adjusted R2 0.211
Breusch-Godfrey serial correlation LM test: (after first difference) Prob. chi-square = 0.388 > 0.05
Heteroscedasticity test: Breusch-Pagan-Godfrey Prob. chi-square = 0.975 > 0.05 Table V.
Durbin–Watson stat 1.967 Long-run
Notes: Details the coefficient for the error correction specifications and the model is calculated over the relationship between
sample period of 1991-2016 using quarterly data; *, ** and *** indicates significant at 10, 5 and 1 per cent market fundamentals
levels, respectively and housing prices

Specifically, it asserts that one-unit increase in housing supply leads to an estimated

decrease of 1.29 units in house price in Greater Sydney. As such, the relation between MHSP
and HS is not only statistically significant but also economically significant.
The relation between median house prices and population shows that population has a
positive effect on house prices. However, it is statistically insignificant. The result is similar
to the results reported by Stevenson (2008); Stevenson and Young (2014) and Otto (2007),
although the results are contrary to the findings of Grimes and Aitken (2010) and Peng et al.
(2016). Importantly, they argued that population would have a stronger impact, in the short
run, on house price as it will lead to an increment of house demand and house prices. As a
result, it is reasonable to document that population has a positive impact on median house
price in the long run, although it is not statistically significant.
The results also suggest that there is a negative long-run relationship exist between MHSP
and Interest (lending rate) rate that is one unit increase in interest rate may lead to 0.313 units
decrease in median house price, although the t-statistics of this variable is insignificant. This
suggests that lending rate has a negative impact on housing prices, but is so to a statistically
significant extent. The results are consistent with the findings of Abelson et al. (2005);
Mukherjee and Naka (1995); Peng et al. (2016); Otto (2007) and Stevenson (2008). Apart from the
relationship between MHSP and INTEREST, this study also found a negative and significant
relationship between MHSP and UNEMP. It suggests that one-unit increase in unemployment
rate would lead to a decrease of 0.824 units in median house price. Comparable results are
found by previous studies in which a long-run significant negative relationship between the
variables are found by Abelson et al. (2005); Bulmash and Trivoli (1991) and Peng et al. (2016).
However, the result is mixed for the relation between MHSP and GDP. While the sign
shows a negative impact on house price for the change of GDP, the results are not in line
with our hypothesis of GDP in which it has a positive long-run association with MHSP. As
housing consumption is a kind of investment (Lee et al., 2017); thereby any investment in
IJHMA property would increase the investment in GDP explicitly. One possible explanation for the
12,4 documented negative result in the case of GDP as follows:
Such as other international housing markets, the Sydney housing market, where the
nature and quality of housing price statistics came under severe scrutiny. Specifically, the
reliability of the official measures of housing prices can be enhanced (Hill et al., 2009, p. 1).
Although housing is considered as vital assets of about 60 to 70 per cent households, yet the
756 statistical information regarding the house price is entirely hopeless compared to the information
on share prices, bond prices, exchange rates, commodity prices, export prices, import prices and
even for consumer prices. In fact, the link in all the price data in the country is the weakest one, so
the matter is something incredibly significant that need resources put into (Ian Macfarlane,
Governor of the Reserve Bank of Australia, 4 June 2004).
In fact, GDP is significantly related to housing prices. So, the limitation of data could be one
of the major factors deliver the negative link in the empirical analysis, although, the result is
utterly contrary to the hypothesis. Importantly, the negative link is also found by Lee and
Reed (2014b) in the Perth sub-market (Table VI).
Another worth noting variable is the coefficient of error correction term. It provides the
insights into the speed of adjustment in cases of disequilibrium[5]. The economic
interpretation of, the coefficient of
0.007 is that the speed of adjustment to the long-run
equilibrium is about 0.01 per cent of departure from the long-run equilibrium. Although a
negative coefficient reveals a correct sign, the speed of adjustment is very slow. In addition,
the coefficient is statistically insignificant, reflecting that market fundamentals are weakly
exogenous to the model. In other words, the disequilibrium between short run value and
long-run value in lagged periods is neither corrected nor extended each period. Thus, the
adjustment to market fundamentals is not lagged but within period through negative
feedback from the error correction. Comparable insignificant error correction term is also
documented by Hendershott et al. (2002) for London commercial rents.
To sum up, the long-run causality analysis suggests that most of the explanatory
variables such as gross disposable income, housing supply, unemployment rate and GDP are
statistically significant in explaining house price of Sydney, although the coefficient of GDP
is not in line with the expected sign. Comparable results are also documented by Lee and
Reed (2014b) for the Perth sub-market. Importantly, the long-run analysis suggests that
housing prices, in general, did not depart significantly from market fundamentals.

4.5 Short run relationship between market fundamentals and housing prices
The VECM also presents the short run relationship between explanatory variables and
housing price. The short run relationships between market fundamentals and housing
prices are depicted in Table VII.
Generally, market fundamentals have little impact on house prices in Sydney in a short
run. Specifically, only GDP at Lag 1 [t-statistics (
2.54)], UNEMP at Lag 1 [t-statistics
(
1.87)] and INTEREST at Lag 2 [t-statistics (
2.22)] are statistically significant,
suggesting that these three variables can explain the Sydney housing price growth over the

Particulars Coefficient Standard error t-statistic

ECM
0.007* 0.026
0.286*

Table VI.
Error correction Note: This reveals the error correction term; *, ** and *** indicates significant at 10, 5 and 1 per cent
coefficient levels, respectively
short run, whilst other variables have a weak explanatory power in the short run. One Housing prices
possible explanation could be the investment activities of the Sydney housing market. As and market
discussed Lee and Reed (2014b), larger housing markets such as Sydney and Melbourne are
more likely to have speculative investments compared with smaller cities. The speculation
fundamentals
activities may have a stronger impact in the short run (e.g. transitory volatility) (Lee and
Reed, 2014b). Therefore, in the short run, this is not surprising to find that these market
fundamental variables have little causality link with housing price individually. However, in
the aggregation of the explanatory variables, these variables do have some impact on
757
median house price in an aggregated term. To consider this, a Wald test was also
undertaken. The results are reported in Table VIII.
Results here suggest that these key market variables can jointly cause short run
causality to the dependent variable.The documented results are consistent with the findings
of Abelson et al. (2005), where housing prices, over the short run, are heavily influenced by
the combination of the market fundamentals.Further, the diagnostic tests show that the
ECM is correctly specified in light of the model is free from serial auto-correlation and
heteroscedasticity and that the residual follows the normal distribution.

5. Conclusion and implications

Sydney housing price has increased significantly in the past 30 years. Given housing is a
critical component of an economy, an unsustainable growth of housing price could lead to a
housing bubble, which would have a significant economic impact on the economy.
Theoretically, housing price growth should be explained by market fundamentals in a long
run. At such, this is critical to investigate whether fundamental factors can explain house
price in the long run. However, the linkages between housing prices and market
fundamentals have not been fully understood. This study aims to fill this gap by using a
VECM and a cointegration test to explore whether a cointegration relationship exists among
macroeconomic variables and housing price in Greater Sydney in the long run. Specifically,
the long-run determinants of housing price over 1991-2016 were also identified.

Lag 1 Lag 2 Lag 3 Lag 4

Variable Coef. Coef. Coef. Coef.

GDP
0.801 (
2.541)***
0.101 (
0.300)
0.041 (
0.111)
0.460 (
1.400)

GDI 0.390 (1.462) 0.301 (1.100) 0.072 (1.461) 0.351 (1.461)
HS 0.070 (1.250)
0.020 (
0.351)
0.042 (
0.781)
0.010 (
0.300)
POP
6.101 (
0.722)
3.091 (
0.351) 9.622 (1.112) 0.570 (0.071) Table VII.
INTEREST 0.020 (0.240)
0.201 (
2.221)*** 0.100 (1.071)
0.041 (
0.411)
Short run
UNEMP
0.121 (
1.872)***
0.042 (
0.633) 0.010 (0.090) 0.060 (1.020)
relationship among
Note: Figures in parenthesis are t-statistics. *, ** and *** indicates significant at 10, 5 and 1 per cent levels, variables and
respectively housing prices

t-tatistic Value

F-statistic 1.491*
Chi-square 35.711**
Table VIII.
Note: *, ** and *** indicates significant at 10, 5 and 1 per cent levels, respectively Wald test
IJHMA Several key findings have been identified in the study. First, macroeconomic variables, in
12,4 the long run, are cointegrated with housing prices of Greater Sydney. This suggests that
there is a long-run relationship between housing prices and market fundamentals. Second,
among these variables, gross disposable income, housing supply, unemployment rate and
GDP are statistically significant in explaining house price of Greater Sydney in the long run,
althoughthe coefficient of GDP has an opposite sign. Nevertheless, population and lending
758 rate are insignificant in explaining housing price of the Greater Sydney in the long run.
These indicate that gross disposable income, housing supply, unemployment rate and GDP
are the key determinants of housing price in Greater Sydney in the long run. The finding
confirms that the behavoiur of housing prices in Greater Sydney, in general, can be
explained by market fundamentals in the long run. This also implies that no evidence to
assert that speculative bubbles play a critical role in the Sydney housing market. Finally, the
study found weaker evidence to support the notion that these variables can explain housing
prices in Greater Sydney in the short run. This highlights the differences between the long
run and short run casuality linkages.
The findings of the study have some far-reaching implications. First, the current study
provides some further insights into the debate of whether housing price in Greater Sydney
has departed from market fundamentals significantly. The finding of house prices in
Greater Sydney is cointegrated with market fundamentals in the long-run suggests that
there is little evidence to support the notion of housing prices in Sydney derivate from
market fundamentals considerably. This would offer some insights to policymakers in
relation to whether a tighter monetary policy is required to reduce the risk of housing
bubble. Second, the divergence results from the long- and short-run analyses highlight that
policymakers should consider both dynamics of house prices separately. Although this
study provides some insights into the long-run association between Sydney housing price
and market fundamentals, the debate of whether there is a housing bubble warrants a
dedicated investigation.

Notes
1. Despite some housing price drifts have been observed in 2018, the Sydney housing market, in
general, did perform strongly in the past 30 years.
2. These market fundamental variables were identified from the literature review.
3. As the unavailability in quarterly GDP data at the state level, this study considers the national
GDP data from the ABS.
4. The optimal lag length for the cointegration test was selected based on a number of information
criteria. Given most of the information criteria such as LR, FPE, AIC and HQ indicate the optimal lag
order size at four lags, four lags were selected as the optimal lag length for this analysis. Importantly,
four lags are neither too short nor too long. The results are available upon the request from the authors.
5. The stationarity of the errors is examined. The unit root tests suggest that the series is stationary
and so the ECM approach is validated.

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Corresponding author
Chyi Lin Lee can be contacted at: chyilin.lee@uws.edu.au

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