When are house prices a worry?
(Any opinions expressed here are those of the author and not of Thomson Reuters)
As I speak with a relatively recognizable British accent, travelling by taxi in many Asian countries has become something of a trial in recent years. Whenever my nationality is recognized, I am (courteously) asked for my views on the London property market, and where to buy. In a world of low interest rates, property has become increasingly fashionable, and somehow housing advice delivered in a British accent has become highly sought after.
Property prices in London are now over 30 percent above their pre-crisis level. For the rest of the UK, house prices are now back where they were before the onset of the economic crisis (it should be noted that the economy is around 13 percent larger in nominal terms over the same period, so the house price to GDP ratio has fallen for the country as a whole). In the United States, house prices have yet to regain their pre-crash levels, but they are up 20 percent from their lows. Even in the Euro area, not an economy noted for its vibrancy, German property prices are 10 percent higher than they were before the crisis.
The increase in property prices is starting to attract the attention of policy makers – certainly in the United Kingdom, where there is a great deal of media focus on the issue. The interesting question is at what point should property prices become a cause for concern for policy makers? As with most issues in economics, there is no simple answer.
Rising property prices, in economic terms, are neither automatically good nor automatically bad. Rising prices of any asset are neither good nor bad – if a price increase means that an asset is fairly valued, it is good, if a price increase means that an asset is unfairly valued then it is bad (a concept that television reporters covering equity markets would do well to learn). A changing asset price should not, of itself, worry policy makers. What will worry policy makers are the consequences of rising property prices. There are four areas of focus.
1. Leverage. This is the big one. If rising property prices cause consumers or banks to increase leverage, policy makers need to be concerned. This can arise because consumers are borrowing more to buy a property or because consumers are reducing their savings rate as a result of feeling wealthier (as their economic wellbeing is fuelled by property values). If banks feed this leverage by allowing credit to grow too rapidly, that is also a legitimate concern for policy makers.
2. Construction. If rapid house price increases lead to a construction boom, this may be an unwelcome diversion of economic resources. Economics is all about allocating scarce resources, and housing is not a very productivity enhancing area of investment. If the housing sector is getting too many resources amidst rising prices, then other sectors of the economy will not receive the right resources to allow the economy to grow in the future.
3. Labour mobility. If an increase in housing prices makes some areas “unaffordable”, and this prevents people from moving to places where there are jobs, this is something policy makers need to worry about. The issue is complex. If house prices rise but rents remain low (because there is a demand for “investment properties” that are subsequently rented out), then there is no problem in theory. However, if people are emotionally attached to the idea of owning their own home, then the aversion to renting combined with high property prices may create labour immobility, which can damage an economy’s efficiency.
4. Protectionism. If foreign investors are purchasing properties (and in particular if those properties are not then rented out, but instead allowed to stand empty), then foreign purchasers of property may become a target of hostility for the domestic population. This can then be manifest through restrictions that target foreign owners – either overtly (as with Australian regulations) or more covertly (higher taxes on empty properties, as with the United Kingdom). The real danger is that the narrow protectionism of the property market expands into a more generalised protectionism, once the idea of singling out foreigners has been made “acceptable” by the housing market precedent.
Policymakers should take account of property market moves when one or more of these problems manifests. Their response may include tighter monetary policy, changing land use regulations, taxation changes, limits on bank lending, or the overt protectionism already mentioned. With the UK specifically experiencing at least the second, third and fourth problems highlighted above, additional policy responses do seem likely. This means that when hailing a taxi in Asia next year, my accent is more likely to provoke a gentle pity about the performance of the English cricket team than a detailed interrogation on the relative merits of Battersea versus Canary Wharf.