All things being equal, lower interest rates spur both housing development and the price level of the existing housing stock.
Clearly new housing development adds directly to economic activity. But there’s also the economic theory that higher prices for existing houses (share prices and other assets) creates a ‘wealth effect’ – windfall recipients feel richer and spend some of that largesse, boosting the economy in the process. Call me sceptical.
My wife and I own no property, but we’d like to one day. As we’re natural born savers, it’s hard to say how much our savings rate is influenced by Sydney house prices. But with each uptick in property prices, I do get a bit more antsy about frivolous outgoings.
My older brother has been a supposed beneficiary of the housing boom and its wealth effect, he bought his apartment 15 years ago and it is worth multiples of his purchase price now. But a two-bedroom pad is becoming a squeeze with two kids, so he is an aspirational upgrader. Each uptick in house prices makes that harder, and means savings are prioritised over spending.
Like me, my two younger brothers are effectively short housing (renters). Unlike me, they’re not natural born savers. But they’d like to own one day, and have been saving hard to make it happen over recent years. Of course, that is as it ever was – joining the property ladder always required sacrifice. But the higher local house prices, the more they need to save.
There’s a reverse wealth effect going among our cohort. Rising house prices mean we need to save more, and that’s money not being recirculated into the economy.
Of course, there are also housing boom beneficiaries among my family and friends – including some friends that formed families and took on mortgages at a younger age, but particularly baby boomers like my parents, aunties and uncles.
The older generation in my family generally own suburban bungalows that are worth nearly a million bucks today, rather than say the $500,000-600,000 they might be worth if valuation metrics like house price to median family income were back at mid-1990s levels.
And the amount of incremental spending they’re making because of all this extra unrealised capital gain? Close enough to zero that we can round down.
If the market gapped up tomorrow and such houses sold for $2 million instead, it wouldn’t change my parents’ habits or plans one iota. They would continue doing their best to live off their superannuation and other liquid assets. But it would almost certainly cause my brothers and me to increase monthly savings.
Of course, this is purely anecdotal evidence and leaves me open to accusations of logical fallacy. It is not proof of anything. It could also be that the increased property development that occurs because of higher general house prices outweighs any such concerns.
But the wealth effect as economic gospel looks suspect to me, especially as it relates to an essential need like housing. The reduced spending of those of us who own no houses but aspire to, or own smaller houses than we want, dampens and perhaps even cancels out any positive from those that do own property.
Funnily enough, ABS data released today shows disappointing Australian retail sales for April, with year on year growth of 3.6% (and trending down fast). That compares with annual house price growth of around 10%. The whole wealth effect concept is perhaps due a rethink.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.