Do international property prices impact our economy?
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 generally true globally, this is certainly the case here
in Australia.
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 per cent 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 seven per
cent.
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.
When it comes to measuring home affordability, there are a number of measures. One way is the ratio of house prices
to after-tax incomes. On this measure alone, on a global basis, Australia appears to be very expensive, certainly more
expensive than China.
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.
So, what happens to house prices in the world’s economy really does matter.
Chinese house price change
Source: National Bureau of Statistics of China