Often lost in the debate about house and home prices in Australia is the discussion regarding if our national obsession with housing is good or bad for the overall economy. Instead of rejoicing that residential real estate prices in Australia rose during the global financial crisis, maybe we should be looking a little closer at why prices are rising to see what problems this might be causing.
I am not going to touch on the subject of whether Australian home prices will rise or fall in the short to medium term or if housing is a good investment or not, since much of this has already been previously covered in a variety of articles which can be found on the Australian House Prices and Real Estate Discussion page of this site.
What I will focus on instead is the question: are rising house prices in Australia good for economy.
Many people would probably say the answer is obviously yes and that of course rising home prices are good for the economy because they create wealth. In addition many would would point out that a home is a safe investment and as the value of the home rises, it creates equity which in turn people can use for a wide range of purposes including investing in the stock market.
So it’s a win-win situation right? Well perhaps not quite.
Firstly the reason people can afford bigger and better homes is not only due to rising wages and productivity improvements but also because of rising levels of household debt. Many economists don’t see this as a major problem because this debt is against an asset (i.e a home) which should rise in value and therefore, generally speaking, will keep household net debt under control.
But this sort of thinking is what caused a lot of pain during the global financial crisis and sent many investment banks and companies under. Some very ‘smart’ bankers figured that they could deal with high levels of debt because they would simply pay the interest off using the income stream generated by asset and then at some point, also make a tidy profit by selling off the asset itself.
But as we know this didn’t quite work out for the likes of Babcock & Brown and a whole range of other companies. Indeed many property developers have also failed or hit hard times in recent years despite a rising population and a supposedly robust economy.
The important thing to remember about debt is that it doesn’t go away until you have paid it off and if the value of the asset you borrowed against goes down in value, then you can be in serious trouble.
But that is unlikely to happen to Australian house prices right? Maybe, maybe not, but most people appear to believe that over the long term (10 years plus) that they will see the value of their home or residential investment property rise. They are in fact, counting on it.
We can see how this belief is playing out in terms of household behaviour by looking at Australian household debt levels as per the chart below.
As we can see from the chart, from the early 1990’s Australian’s started taking on bigger loans and as a result household debt levels as a percentage of disposable income have soared.
But on the plus side the value of the homes people have borrowed against have also risen so maybe all is well? Many property bulls would also point out that Australian households are wealthier than ever before and so if house prices continue to rise then the good times will continue to roll on.
That line of reasoning would not worry me so much if household savings were also rising, but that is not the case as I discussed in: The unbalanced economy and household savings in October 2010.
A little more worrying is that productivity gains across the Australian economy have pretty much stalled and inflation is rising. This means that the nations ability to earn more is flat-lining while at the same time the cost of living pressures mount.
The family home for most people will be the biggest single asset they will ever own and so strong is the belief that it will deliver a capital gain, that national house prices kept rising even during the global financial crisis. In others words, not even a global economic crisis could undermine the confidence Australian’s have in the housing market.
On the surface this would appear to be a good thing. The resilient Australian economy weathered the global economic turmoil of the last few years and despite house prices falling across much of Europe, Japan and in the U.S, the housing market in Australia powered ahead.
But let’s not forget that all the money flowing into housing is essentially going towards a somewhat non-productive asset. True people need shelter, but across Australia there is a significant amount of over investment in the housing market. Hundred of billions of dollars are tied up in homes that have more rooms than are needed and in improvements such as swimming pools and BBQ areas etc. Then there is also a small fortune tied up in holiday homes which are often vacant for most of the year.
Bigger houses, swimming pools and holiday homes don’t do much to increase productivity or make the economy better able to compete in the global market place. Yes they do make people feel wealthier and yes technically they are assets, but no economy anywhere in the world has ever secured it’s long term economic future because it had the nicest or most expensive homes.
This leads me to wonder if rather than rising house prices being good for the economy they become at a certain point, a barrier to further economic growth and productivity gains. If so, are home prices in Australia now near or at that point?
As a nation, are we simply taking the proceeds from the commodities boom and essentially over investing it in residential property? Perhaps over the last decade or so Australian’s have essentially become use to a lifestyle that will become increasingly difficult to maintain if commodities prices enter an extended period of price decline?
Even more concerning is that perhaps rising house prices are masking weaknesses in the economy we don’t see, or don’t want to see.
I don’t pretend to know the answers to these questions, but I believe that they are the sorts of questions we should be asking ourselves and that our policy makers should be looking at as well.
Let the discussion begin now!