Do international property prices impact our economy?
12 Dec 2014
By Shadforth Financial Group
With many people having the majority of their wealth tied up in the value of their homes, house prices have a significant impact on an economy. While this is generally true globally, Australia is perhaps more sensitive to property price movements than most countries.
As we have seen in recent years, the outlook for residential and investment property can have a significant impact on a region's economy. Low financing costs, low documentation loans and over supply contributed to a major correction in house prices which ultimately resulted in a severe credit crisis in the US. Since then, as demand catches up with supply, the US property market has been gradually recovering.
In China, average house prices are showing some weakness. Although prices in both Shanghai and Beijing have recently corrected, if Chinese house prices do not stabilise of their own accord, further government policy intervention may be required. While we are seeing restrictions being lifted in some regions, we anticipate more stimulus may be required at the national level. As new home sales slump, in a bid to reduce their inventories, there is evidence of developers slashing prices. Over the next couple of years, while this should help in rebalancing the supply/demand equation, highly geared developers may not survive.
A major contributor to Chinese economic growth has been Fixed Asset Investment (FAI). Last year, it was estimated that housing represented around 20% of FAI but, in 2014, this contribution is likely to reduce. As a result, slower sales together with reduced residential construction activity should slow the Chinese growth rate to below 7%.
While the Chinese banks are not immune to severe housing downturns, the Chinese household has relatively low debt levels, certainly much lower than that of Australians.
International comparisons of property prices are notoriously difficult. Ensuring apples-for-apples comparison is particularly challenging. A common measure of home affordability is the ratio of house prices to after-tax incomes. On this measure, Australia appears to be very expensive, certainly more expensive than China. Of course this measure fails to take into account the relative attractiveness of living in China compared to Australia or the fact that the average Australian home is much larger than its Chinese equivalent. A final point of difference is that all Chinese property is effectively leasehold while the majority of residential property in Australia is freehold.
The decline in property development also has a flow-on effect to iron ore prices. Steel is a major component in the housing construction industry and, with construction slowing as well as increased iron ore production, the price of iron ore has eased to a little under US $77 a tonne. As prices and demand weaken, the potential for iron ore surpluses also increases.
The prospects for Chinese economic growth are heavily influenced by government policy while consumer sentiment and behaviour (consumption) are impacted by house prices. Consumers tend to be more optimistic when house prices are rising and less so when they are falling.
While we cannot profess to know where real estate prices will go in China, we can observe that a sharp downturn in prices could have negative implications for the Chinese economy. The flow on effect to Australia (other than in lower iron ore prices) is less clear.
Our base case is that Chinese house prices stabilise (albeit potentially at lower levels) and the Chinese residential real estate market goes through a period of necessary, but manageable adjustment.
Perhaps the best hedge against a severe property downturn in China is not to have an overexposure to resource companies and have at least part of your international share exposures unhedged. In the event that a sharper slowdown in China has a greater than expected negative impact on the Australian economy, this would partially protect your portfolio of international shares.