UNDERSTANDING THE WORLD HOUSING BOOM SINCE 1970—A research report review

In December 2008, the Reserve Bank released a series of Workshop Papers.  A paper of particular interest is titled “Understanding the World Housing Boom”, by James Kahn, Wharton School, University of Pennsylvania.  Kahn examines housing prices since 1970, across 18 countries including Australia.  He constructs a model that explains why home prices consistently grow faster than economic growth, both across countries, and over time.  The report can be found on http://www.rba.gov.au/PublicationsAndResearch/Workshops/2008/kahn.pdf .  It is very technical.  The most interesting results are briefly outlined below.

1. Home prices consistently grow faster than output, over time and across countries

The chart below shows that for almost all countries, home prices grow much faster than inflation.

• The base is set at 100 for 1985
• From 1970 to 1985, all but one country showed substantial growth (over and above inflation)
• From 1985 to 2007, all but three countries showed growth above inflation, ranging from 50% to 350%

This busts the myth that property prices will not grow faster over time than nominal GDP.

2. Australian home price growth is not unusual by international standards

The chart above shows that Australian home price growth, adjusted for inflation, sits in about the middle of those 15 countries that showed price growth.

This busts the myth that Australian property prices are out of line with global standards.

3. Home prices grow faster than other assets  because, as people become wealthier, they consistently choose to put a disproportionate share of this wealth into property

The two charts below compare consumption growth and house price growth across countries.  Each dot represents one country.  The red line shows the average relationship across all the countries.  It is clear that low growth countries have low house price increases, and high growth countries have high house price increases.

The slope of the red lines are about 2, meaning that if we move from a low growth country to a high growth country, we find that the high growth country outperformance is twice as strong in house price growth as in consumption growth.  This is consistent across the two time periods 1980-90 and 1990-2005.

The next chart shows what happens when growth changes within a country.  The slope of the red line is 2.6, which means that within a country, consumption growth will lead to house price growth of about 2.6 times as much as consumption growth.   This means that when the trend growth rate of a country increases, there tends to be a spike in house prices, before reverting to normal trend.

4. The fact that house prices increase faster than output, leads to a rise in the contribution  that housing wealth makes to total net wealth

The chart below is volatile, mainly because of the impact that enormous equity market fluctuations have on total net worth.  Nevertheless, the upward trend in the contribution of housing wealth to total is evident.

This paper is useful because it demonstrates some fundamental truths, that hold over time and across countries:

• House price growth (over and above inflation) will over the medium term consistently grow faster than output (about 2 to 2.6 times faster)
• This is because consumers choose to place more of their increasing wealth into housing than other avenues
• Australia’s housing market performance since 1970 has been about the same as most other countries