Consumer wealth effect – Another nail in the coffin for retail spending.
Consumer spending has risen strongly in the past year, spurred on by property owners feeling richer due to higher house prices. This is called the household wealth effect. But with house prices looking toppy, should retailers – and investors – be concerned about the effects of a property market correction?
As readers know, we are very negative on both Australian retail companies and the property market. The development of both these sectors is linked, but the exact level of linkage is hard to quantify.
We were therefore interested to read the recent Australian Housing and Urban Research Institute report “Housing prices, household debt and household consumption” showing the impact on consumer spending from the wealth effect from higher property prices (i.e. consumers spend more when they feel wealthier even though the wealth is tied up in illiquid assets).
The key findings from the report are:
- There are different behaviours in different age groups to the change in house prices. The older you are, the more likely you are to increase your spending due to a perceived wealth effect. This makes intuitive sense, as your underlying cashflow is better due to a lower level of mortgage, and lower costs (e.g. you don’t have kids in the house anymore). Due to a lower level of mortgage, you are also more likely to be able to take out additional loans on your property.
- There is a BIG difference between owner-occupiers and owner-occupiers who are also investors. Investors are about two times more sensitive to changes in house prices compared to people who do not own an investment property. This makes intuitive sense as these people are feeling more wealth effect due to their increased exposure to property values.
- Investors (or rather speculators) with high level of loan-to-value ratios are more likely to increase their consumption compared to owner-occupiers. That is, investors are treating investment property more like a credit card than a necessary utility or a long-term cash generating asset.
- Overall, on average across all property owners, a household is likely to increase its annual consumption by $31/week or about $1600 per year, for every $100,000 increase in value of their house or about 1.6% all else being equal.
If we look at the value of the total residential housing stock in Australia, it is (according to ABS) about $6.1 trillion at the end of 2016 and it has been growing by about 8% per year since 2012.
This means that the total increase in consumption for 2016 from the increase in house values was about $6.1 trillion *8%*1.6% = $7.8 bn. The previous years were slightly smaller due to the base effect, but let’s say the wealth effect is $6-7 bn on average per year.
Total retail turnover in Australia was in 2016 $122 bn and it has been growing by about $4 bn per year.
Now, all the increases in household consumption are not going to be spent in Australian retail shops (the overseas holidays etc. will take their share!). We are though prepared to wager that quite a lot of the growth in retail spending over the last 5 years has come from the wealth effect of people feeling wealthier due to the increases in house values.
Given that we are bearish on the development of property prices and consider at least Sydney and Melbourne to be in significant bubble territory, we are hence very careful with projecting any growth in retail spending. Even if we only get a flattening out of property prices, the impending entry of Amazon means that Australian retail companies will have to contend with increased competition without the help of the steroid injection of property wealth related consumption spending. On top of this, we have very stagnant real wage growth and significant upcoming increases in non-discretionary costs like electricity, which together paints a very dire outlook for retail spending.