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Is Australia’s housing sector 20%-30% overpriced?

As reported in today’s Fairfax press, Australia’s housing market is between 20% and 30% overvalued according to one of the nation’s top economic experts, Jeremy Lawson. This leaves the economy and the share market extremely vulnerable to a potential downturn.

Housing prices have risen at an alarming rate as a result of easy monetary policies around the world as well as regulators’ reluctance to implement so-called macro-prudential tools to slow pricing growth. Indeed, the Reserve Bank of Australia has the nation’s official cash rate at just 2.5% and has indicated the low rates are here to stay for the foreseeable future.

With low rates on offer, we have seen a stark increase in mortgage lending activity which now has house prices sitting 26% above their peaks before the GFC and 11.2% higher over the last 12 months, according to The Australian Financial Review.

This poses as a significant threat for the big four banks, and in particular Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC), which carry the highest level of exposure to Australia’s housing sector. Should the property sector begin to show signs of a downturn, we could see their share prices fall substantially.

In regards to the effect such an event could have on our sharemarket, we only need to look as far as the weighting of the big four banks in the benchmark S&P/ASX 200 (INDEXASX: XJO) Index. When combined, Commonwealth Bank, Westpac, National Australia Bank Ltd (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ) make up roughly 29.6% of the index. As such, a large correction in their price would see the index pounded.

That is one of the primary reasons it is crucial that the banks be required to hold additional capital in reserve. Given the Australian economy’s reliance on the major banks, a downturn could prove catastrophic if the banks are unable to support themselves.

A better bet than the banks

I have long been bearish on Australia’s big four banks. Aside from their high-level of exposure to Australia’s red-hot property market, I also consider each of the banks to be heavily overpriced.

A company I am much more bullish on is a small cap stock with fantastic growth potential as well as a generous 6.7% grossed-up dividend yield! Our top analyst recently dubbed it, "The Motley Fool's Top Dividend Stock For 2014 - 2015". Best of all: You can get its name and code of this ultra-promising stock for FREE! Just click here to download your free copy of "The Motley Fool's Top Dividend Stock for 2014-2015" today.

Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

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