Thursday, May 03, 2007

 

Real Estate, Wealth Accumulation And The Rise Of Prosperity


On whether it is wiser to treat real estate capital accumulation as a nest egg or as a credit card, that is to save as opposed to spend.
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Prosperity, in Capitalism, is the epitome of financial stability, reliability, and security.

It can be more easily thought of as an abundance of items of economic value, or the state of controlling or possessing such items, and encompasses money, real estate and personal property. Particularly as it relates to the field of Real Estate, it can be safely stated that when house prices rise, so does prosperity. This is so because there exists a well-established link between housing wealth and spending, which makes an increase in prosperity - both as a nation as well as at individual levels - in direct function of an increase in spending which, in turn, increases the acquisition of all the aforesaid items upon which prosperity is founded.

When house values increase - especially as dramatically as in recent years - people feel freer to spend from the wealth they have, or the wealth they perceive they have. They may decide to buy a bigger car, to eat out more often, to indulge in electronics or fashionable items, all of which is in most cases financed by their equity. And, strangely enough, people spend their hypothetical riches faster when their houses go up in value than when their stocks do, because they believe that housing gains are more stable.

In response to this greater affluence, the general trend of people is to increase their spending. Conversely, when housing values diminish people cut back spending in a similar way. The general consensus is that a $100 drop in wealth, over time, reduces spending by about $5.00 per year. This suggests, therefore, that weakening housing prices have a mild effect on consumer spending, to the tune of an approximate annualized rate of spending reduction of five percent.

This makes sense, in that economic theory tends to support the fact that rational consumers ought to adjust their long-term spending in response to changes in their wealth, not the ease in which they can tap it. But there is another element equally important to be factored into the determination of the level of prosperity: how well debtors manage their debt. For instance, the Mortgage Bankers Association (MBA) reports that seasonally adjusted index of mortgage application activity, which includes both refinance and purchase loans, increased 3.6 percent to 575.6 for the week ended December 29, 2006. The index stood at 555.8 the previous week, which was its lowest level since early August. Demand for home refinancing loans also strengthened as the MBA's seasonally adjusted index of refinancing applications increased 2.2 percent to 1,640.4. In 2005 the index stood at 1,363.2.

This evidence would suggest that consumers are using more of their home equity to pay off other borrowings such as credit card debts, in light also of the fact that mortgage debt in both the United States and Canada carries considerable tax advantages. This is another indication that, contrary to the forecast of some analysts, consumers manage their debts prudently, not recklessly.

The equilibrium in the issue as to whether consumers ought to treat their housing wealth as a nest egg or as a credit card - that is whether they should save rather than spend - is to be found in the ratio of spending to personal income. Surveys have shown that this ratio has peaked at more than fifty percent in 2005, meaning that people spent more than fifty percent of their disposable income using mortgage-equity withdrawal. This in turn would indicate that a slowing of mortgage-equity withdrawal could drag down spending faster than anticipated. The stakes here are high, because the behaviour of consumers will largely determine whether North-American economies will tumble into a recession or will merely slow down. This is so because in North America housing wealth has a bigger influence on consumption than other financial assets such as stocks and bonds.

Which in turn means, once again, that the level of prosperity is affected by the degree of spending proximately derived from the real capital wealth of consumers.

Luigi Frascati

luigi@dccnet.com
www.luigifrascati.com

Real Estate Chronicle

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Comments:
Very interesting article. The fact that we see housing as a stable investment makes sense. People are spatial beings and being able to see their home is better than imagining $15000 in stock.
 
Nice Blog, Will vist again Mortgage Tools
 
"In response to this greater affluence, the general trend of people is to increase their spending." In the oposit way, people wont spend any more and then the crisis rise.
 
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