Australian house prices aren't overvalued yet but there are ''worrying trends'' in some states, Moody's reports.

Australian house prices aren't overvalued yet but there are ''worrying trends'' in some states, Moody's reports.

House prices are not overvalued yet, but negative gearing tax breaks have added almost 9 per cent, or $44,000, to average prices, financial group Moody's Analytics has reported. 

While properties are not overvalued, there are ''worrying trends'' that could come back to bite home buyers when interest rates rise, as rents and incomes have failed to keep pace with surging property prices, the report cautions.

Moody's compared house prices with long term valuations – taking into account rents, income and the costs associated with borrowing, including interest rates and other charges – to assess whether the 10 per cent year-on-year rise in house prices in Australia's eight largest cities means property prices were overvalued.

Its analysis shows that 18 months ago house prices in all states were undervalued.

But rising house prices, which have not been accompanied by rising incomes or rents, have now pushed property values in most states to "fair value".

The report said ''worrying trends'' are emerging in NSW and Victoria, as present home valuations are a function of record low interest rates, which will ''inevitably normalise'' and increase towards a rate more in line with historical trends.

When Moody's calculated the impact of rising interest rates, ''the story begins to change, with nationwide prices trending towards overvalued under normalised interest rates'', the report says.

The strong run up in NSW property prices meant valuations have moved to ''slightly overvalued'', it says.

Were it not for the recent surge in NSW rent costs, house prices there would have been even further overvalued.

Under "normalised" interest rates, the NSW market also looks overvalued.

Within individual states there was also variation between areas, as well as between house prices and apartment prices, the report found.

Outside NSW and Victoria, the trend towards the higher prices that lead to overvaluation was less pronounced, it found.

''Higher prices might not be a problem if matched with fundamentals,'' the report says. ''Rising incomes and rents or falling interest rates can increase the equilibrium value of housing.''

The Moody's report also explored the impact of negative gearing – the tax break that allows the difference between rental income and interest payments to be written off against taxable income.

The report said negative gearing costs the federal government about $4 billion in lost revenue a year and noted economists had labelled it "an unfair and unproductive distortion".

The impact of tax ''distortions'' such as negative gearing in encouraging investment and lending in the housing market was also raised recently in the interim report by the David Murray-led financial systems inquiry.

The Moody's analysis, which incorporates the impact of negative gearing in ''user cost'' estimates, says it adds about 9 per cent or $44,000 to present average house prices.

With low interest rates, the impact of the tax break has fallen from a 2008 peak of 15 per cent, ''yet even today's 9 per cent support is a substantial subsidy to the nation's homeowners'', the report says.