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Don't be fooled by the 'wealth effect' of a rising house value

In fact, in the latest house-price indicator from The Economist, New Zealand house prices are second highest (behind Canada).

This is nothing to be proud of and does nothing to make us wealthy. Although home owners may feel wealthy (and spend accordingly) only a few people take advantage of the high values and free up some cash by down-sizing.

There are also a few speculators who make the right call and do well, but most homeowners are really no better off.

Even though they may now own an expensive house, they still own a house in which they live and that house is no better and no worse than it was before.

Nevertheless, there is no denying that there is a "wealth effect" from rising house prices. Even average home owners in Auckland now find that they have something worth around $1m.

And, because they perceive themselves wealthy, they feel they can consume more.

Moreover, the quality of what these people buy also rises. The things that used to be good enough are now considered inferior: with a $1m house, they think themselves wealthy and want the best.

A more valuable house does not put cash in the home owner's pocket ready to spend – much of the increased spending comes from debt.

Nevertheless, cash is never far away: if a home owner is feeling wealthy, it is easy to borrow in one form or other.

Many people have revolving credit facilities which means they can draw funds on their everyday accounts without consulting their banks.

Even when they do not have such facilities, it is easy (albeit more expensive) to buy on hire purchase or to load up a credit card.

Nevertheless, it is still spending by borrowing. These home owners have not saved the money and they are not buying stuff because they have a surplus.

A more valuable house has not made any difference to their incomes.

In any event, no matter how the spending is managed, remember that the wealth effect is only a feeling: a false perception leading to greater expenditure.

The wealth effect is often thought to be very good for a country's economy as economic activity increases. However, it can be a disaster for the individual.

Mostly the things which home owners go out and buy are "value losers"; things like cars, appliances and furniture which fall in value soon after they are purchased.

Worse are things like holidays and clothes which are worth nothing once bought. Borrowing to buy these things is plain crazy.

The wealth effect may spin the wheels of the economy, but buying stuff on credit is really a quick road to ruin.

Real Estate Investar Editor
Real Estate Investar Editor
Real Estate Investar provides intelligent software, tools and data to help you save time and make money in the residential property investment market.

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