Indebted property investors less risk averse

by Miklos Bolza26 Jun 2017
New research has found a positive relationship between changes in house prices or wealth for property investors and general levels of consumption, exposing a trend which could pose real risks to the economy.

The paper, entitled Housing Prices, Household Debt and Household Consumption, was compiled by the Australian Housing and Urban Research Institute (AHURI) and found that middle aged home owners were more likely to increase their expenditure or borrow more than the younger or older demographics.

Before the global financial crisis (GFC), an increase in housing values of $100,000 correlated with an average annual increase in consumption between $1,000 (for old aged households) and $1,700 (for middle aged households).

This moderated slightly after the GFC with the same increase in housing value resulting in an average annual increase of consumption between $600 and $1,600 for old and middle aged households respectively.

“The findings from the analysis are consistent with the hypothesis that the increases in housing prices affect household consumption through the relaxation of a credit or collateral constraint that enables households to increase their borrowing in order to finance consumption,” the paper said.

However, the study found house price movements have had little impact on the pre- and post-GFC consumption responses of owner occupiers who are not rental investors.

Furthermore, the response of rental investors depends on whether or not the individual had mortgage debt on their rental property.

Prior to the GFC in 2003, owner occupiers with rental investment properties increased their consumption by approximately $2,500 per annum for each $100,000 increase in house prices. This was higher compared to $1,700 for owner occupiers who did not own an investment property.

In 2009, after the GFC, an investor increased their consumption by a larger amount: approximately $2,800 on average annually for every $100,000 rise in house values. In comparison, non-investors only boosted their consumption by an average of $1,600 per year.
 
Looking at the different types of investors, the study found that those with no debt became more conservative after the GFC, reducing their average consumption from around $3,000 to $2,600. On the other hand, those with more mortgage debt increased their consumption from $1,700 to $2,900 per year.

“The results for investors with and without debt prior to and following the GFC suggest an amplified role of the collateral channel for investors. That is, the relaxation of credit constraints for investors appears to be an important determinant of how responsive such households are to a change in house prices.”

These findings are relevant for macro-economic stability in Australia, said associate professor Stephen Whelan from the University of Sydney.

“In particular, the finding that households with higher levels of debt are most responsive to increases in house prices highlights a potential systemic risk.

“Financing higher consumption through taking debt among highly leveraged households exposes those households to the risk of significant loss if house prices fall or if interest rates rise.”

This contrasts the general belief that debt is held by those most capable of servicing it such as those with higher income and higher wealth households, he said.

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