Yahoo Finance OPINION: The benefits of booming house prices
Almost all of the analysis of Australia’s property market focuses on the problems associated with rising prices.
It is judged that sharply rising house prices have been a factor reducing home ownership rates because young people, in particular, are squeezed out of the market due to the difficulty in saving a 20 per cent deposit and then taking on ever-increasing mortgages to step into the market.
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There is an element of truth in this analysis and there is the added issue of the tax system favouring investors in residential property, which also has an impact on house price growth.
What is always overlooked, however, is the benefit to Australia from the wealth that is created from the strength in house prices over many decades.
The Reserve Bank of Australia (RBA) has published a range of research that calculates the effect of changes in wealth due to house price changes on broader economic conditions.
An insightful paper on the topic, called Wealth and Consumption, written by RBA researchers Diego May, Gabriela Nodari and Daniel Rees, showed - in what is an unsurprising finding - that changes in household wealth, due to changes in house prices, impacts the growth rate of household consumption – spending, in other words.
In simple terms, they found that when wealth increases as house prices rise, spending growth rises. When house prices fall, spending growth slows.
This makes intuitive sense.
If a householder experiences, say, a doubling in wealth over time as house prices increase, they will be more inclined to either borrow against that wealth and increase their consumption spending, or downsize and use the wealth created by high house prices to increase their spending.
Either way, the effect is clear and has been evident in Australia for many years.
How housing wealth affects consumption
In simple terms, the RBA research found that a 10 per cent increase in net housing wealth raised the level of consumption by around 0.75 per cent in the short run, and by 1.5 per cent in the longer run.
These are significant numbers given that, in an average year, household consumption rises by around 3 per cent.
This estimate fits with the experience since the mid-1990s, where Australia has had strong growth in house prices, which fed into generally strong growth in the economy and unlike the rest of the world, no recession - at least until the COVID pandemic emerged in 2020.
Over that time, net housing wealth has risen from around 200 per cent of household disposable income to around 400 per cent in 2021. Such is the power of the surge in house prices.
This rise in housing wealth has facilitated growth in household consumption, allowed for generally lower levels of discretionary household savings and has been a factor supporting economic growth.
RBA governor Philip Lowe said recently: “Over recent years, spending by households has risen at a faster rate than household income; in other words, the saving rate has declined … rising housing wealth played a role here.”
It is also clear that rising housing wealth and the associated additional growth in household consumption feeds through other parts of the economy.
The rate of job creation and the level of employment will be higher than it would be if house price growth was weaker.
These more favourable labour market conditions feed into better-than-otherwise wage increases, which would have been even weaker in a scenario where house price growth was weak or non-existent.
Dr Lowe summed this and other effects on the broader economy from strong growth in housing wealth when he said: “Movements in housing prices affect the economy through multiple channels.
“They influence consumer spending, including through the spending that occurs when people move homes. They also influence the amount of building activity that takes place.
“Changes in housing prices also have an impact on access to finance by small business by affecting the value of collateral for loans. And finally, they can affect the profitability of our financial institutions.”
All vital points in the broader Australian economic experience over the past 30 or so years and key factors that would have been severely weaker or even absent if house prices had been stagnant.
Beware of falling house prices
When house prices fall, the reverse effect operates.
This is why it would be troubling to see a sharp fall in house prices in Australia.
Such an event would see a weaker economy, higher unemployment, problems in the banking sector and a slump in new construction.
While affordability may improve, crashing the housing market is not the way to build home-ownership rates.
On the contrary, a house price crash may lead to even lower home-ownership rates if unemployment is higher for longer and banks are limited in who they lend money to.
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