Another year, another massive increase in house prices and more excuses proffered by the real estate industry as to why Australia’s houses are among the most expensive in the world. A survey by the Canadian Bank of Nova Scotia revealed that even after adjusting for inflation, house prices rose in Australia by 9.4 percent in 2010 — more than any other country surveyed.

Interestingly, while German and US house prices remained flat, Canada, a country often compared to Australia due to its strong reliance on mineral exports and healthy banking system actually recorded a 1.5 percent drop in prices in real terms.

Despite being based over in Canada, the analysts at Scotia Bank appear to have gotten the memo from the real estate industry. According to a Fairfax report, the analysts didn’t deem Australia’s price gains have been due to increased use of debt, rather “Scotia Bank analyst Adrienne Warren said Australia’s front-running status was due to low unemployment and tight supply in the housing market.” Craig Stephens from real estate agency Jas H. Stephens agreed, noting that “generally speaking, the Australian housing market is in better shape than those other countries.”

If prices being double intrinsic values constitutes a market in “good shape”, then perhaps Stephens is correct.

That Australia now has a mortgage-debt to GDP ratio of around 90 percent, which is higher than the mortgage debt levels in the US before their housing bubble exploded, is apparently not especially relevant to the good folk at Scotia Bank.

What is most relevant in determining the value of housing (or any asset for that matter) is the potential cash flows that the asset will be able to generate in years to come. In this regard, it is worth noting that ABS data revealed “Australia’s annual population growth rate slowed to 1.7 percent in the year ending June 2010”, moreover, “preliminary net overseas migration estimate for the June quarter 2010 (32,300 people) was 44.3 percent lower than the June quarter 2009 (58,100 people).”

Immigration is one of the key factors underpinning the housing bubble — the promise of more people causing a shortage of dwellings is one of the key planks in convincing people to purchase property when it is effectively trading on a price-earnings multiple of around 50 times (for a median property). Such a valuation may be legitimate if the asset generates constantly increasing returns, but with interest rates rising, near full employment and falling immigration, it is difficult to envisage income from property (in the form of rents) increasing substantially in the coming years to vindicate that valuation.

Over the past year real incomes have risen by around 4 percent — that means, even after more than a decade of housing boom, prices are still clearly outstripping income growth. That means Australians continue to devote more of their wealth to housing, as opposed to other income producing assets. That is a lot of misallocated capital. And eventually, that misallocation of capital will lead to an inevitable drop in living standards.