Is there a relationship between savings rates and real estate values?

Posted by on November 16, 2009 in Money Saving Techniques, Real Estate

To paraphrase the words of the SteadyHand blog, is this a financial crisis well wasted? Last week, ING in Canada and the UK warned of the possibility of a real estate bubble in the residential and commercial real estate market spurred by the low interest rate environment. Beside the obvious bubble and double recession concern (a theory I subscribe to), the issue with rising real estate values is that it tends to act as a negative influence on a household’s ability to save more money.

The reasons are both obvious and not so obvious.  Household savings rates were quite robust (9.6% in the 1970′s) until our paper net worth began to multiple manifold in the 1990′s with the real estate and stock market boom. From the 1990′s onward, we ceased really to save and more often than not consumed instead.

However, studies show a negative correlation between the increase in our net worth and our savings rates. This effect is most pronounced for real estate than the stock market. A 2004 study found that for each $1 increase in real estate worth, we saved 8 cents less.  While for each $1 increase in our stock portfolio, we saved 2 cents less (the link to the paper is quite buggy so I did not link it but google “Real Estate Versus Financial Wealth in Consumption” by Benjamin, Chinloy and Jud to read at your own risk).

Some of the reasoning is obvious. Purchasing a home costs a lot of money and we tend to save less money since we have to make a down payment, pay for movers and new stuff for the house. The more subtle reason is that, for most middle class households, we are restricted in tapping our stock portfolio since the majority of assets are locked into non-accessible vehicles like pensions, RSP’s, 401(k). Finally, on a more marco level, it is easier to save more money when interest rates are higher (like the 1970′s) since there can be a healthy return investing in high interest savings accounts; conversely, low interest rate environments encourage leveraging and its associated effects of increased costs of borrowing on a household budget.

From a practical perspective, one tip to save more money would be to simply to turn a blind eye to the value of your home or, more accurately, remember its only paper wealth and not cash in the bank. If you live in a region with depressed real estate valuations, do not bother looking at the price of your home. Instead, enjoy it.

For those trying to be better savers and living in healthy real estate markets, ask yourself if you really need to buy a larger home rather than wanting a larger home. A lot of people I know are rushing to buy real estate because of favorable interest rates, an external stimulus justifying a want, not because they need a larger home, an internal condition necessitating the fulfilment of a need.

From a larger contextual perspective, if the stimulus has worked too well, and a spike in house hold savings rate is only temporary because the government says its time to consume again, then we truly have short memories and we have no one but ourselves to blame if we suffer another financial stress we cannot recover from. Money in the bank smoothes over a lot of personal finance mistakes.

6 Comments on Is there a relationship between savings rates and real estate values?

By Nurseb911 on November 16, 2009 at 11:06 am

I think there should be concern for sure when you look at how RE prices were affected by this latest downturn. One might even ask, “what effect?”

It just blows me mind that the stock market can still be down as much from its peak, unemployment can be so high but there’s little to no substantial change in the prices of homes. There’s really only one answer for this (and we’ll pay for it in about 5 years). Low interest rates are heavily influencing the amount of money individuals can spend on their homes. Once that changes you won’t see people putting 0% or 5% down on a home for a long time because the interest payments will kill them.

By admin on November 16, 2009 at 11:11 am

Brad- I think you understand why I believe in the double recession theory. We are living in such an artificial economy.

By Canadian Capitalist on November 16, 2009 at 11:41 am

It makes perfect sense that rising real estate values would negatively affect the savings rate. If stocks go up, the “wealth effect” comes from feeling rich. People don’t tend to borrow against stocks to fuel their spending. If home prices go up, home owners might be inclined to tap that increased equity to fund a vacation, a remodeling etc.

By Riscario Insider | @riscario on November 16, 2009 at 11:53 am

Real estate lets us fool ourselves. When you buy stocks, you can tell what your portfolio is worth moment by moment. With real estate, you only know when you have a buyer.

If a house down the street sells for a high price, we think ours is worth more. If that house sells for a low price, we know ours won’t drop because it’s so much better.

Hey, let’s upgrade the kitchen since we’ll get our money back when we sell. We forget that buyers have different preferences. They don’t care what we spent in upgrades. They care only about the value to them. The buyer may only want the land to build a monster house.

We were looking at houses recently and were appalled at some of the crazy designs. A hallway closet that juts into the garage and removes one parking spot. Or a house “upgraded” with vinyl siding in a neighbourhood of brick or stucco exteriors. Or a basement with the kind of flooring you’ll find in school or hospital hallways. The owners overestimated the market values of their houses but did not realize this until they tried to sell at premium prices.

Benjamin Tal at CIBC World Markets said that for every $1,000 increase in the value of our real estate, we feel $80 richer. This lets us turn our house into a bank machine. Why not go out for dinner when it’s “on the house”?

I’d rather build equity for a rainy day than spend it for immediate consumption.

In his early married life, Warren Buffett was loathe to spend on home renovations because he knew understood the power of compounding. Spending $10,000 now was akin to spending $1,000,000 later.

By Riscario Insider | @riscario on November 16, 2009 at 11:59 am

(I messed up the second last sentence. “knew understood” should just be “understood”)

By admin on November 16, 2009 at 12:38 pm

Riscario- its a subject of another blog post, but I agree with you that people put money foolishly into renovating the wrong part of their houses.

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