Rana Foroohar: Real estate, the oldest asset class, continues to dominate modern wealth

Are house prices today equivalent to the price of bread in the past? That was the question a union leader asked recently in Germany, where there is an ongoing campaign to take control of residential rental properties controlled by large companies and turn them into public ownership. Many Dutch cities want to ban investors from buying low-cost rental houses.

South Korea’s ruling party took a beating in municipal elections for having done nothing to curb a 90% rise in the average price of an apartment in Seoul. Chinese leader Xi Jinping has made affordable housing an important part of his campaign for general prosperity, declaring that “houses are for living, not for speculation”.

We know that housing prices are inflated in many places. But a new survey by the McKinsey Global Institute, which tracks the balance sheets of ten countries that represent 60% of world income (Germany, Australia, Canada, China, United States, France, Japan, Mexico, United Kingdom and Sweden) shows some staggering numbers about the volume of money circulating in the real estate market, and the reasons for this to happen.

The study, entitled. “The Rise and Rise of the Global Balance Sheet” looks at the real assets, financial assets and liabilities of households, governments, banks and non-financial corporations. And found that two-thirds of equity is parked in commercial, residential and government real estate, and land. Despite everything that is said about digitization, it seems that the brick is the new brick.

How did that happen? And what are the implications?

The McKinsey study found a strong inverse correlation between equity to GDP (Gross Domestic Product) and the five-year moving averages of normal long-term interest rates.

The authors believe that the fall in interest rates played a decisive role in raising the prices of assets of all kinds, but especially those of real estate. Restricted land supply, zoning issues and over-regulated housing markets also helped push prices higher. The result is that housing prices have tripled on average in the 10 countries surveyed.

The ramifications are disturbing. For starters, asset values ​​are now nearly 50% higher than the long-term average relative to income. Equity and GDP traditionally moved in sync at the global level, despite some deviations on a national basis. Now wealth and growth are completely disconnected. This, of course, underlies much of the populist anger that characterizes politics today. Affordable housing, especially, has become a rallying cry for millennials, who cannot afford to buy houses and start families as early as previous generations.

This, in turn, generates adverse winds for consumption growth, as it makes millennials not buy all the things they would buy to put in a house. It also fuels rent inflation, because a large number of people cannot afford to buy property. All of this helps support the idea that we may be heading into an era of stagflation like the 1970s.

Much of the disconnect between wealth and growth stems from the excessive concentration of money in real estate. But another aspect of the problem is that there is not enough money going into more economically productive places. While rising asset prices accounted for about three-quarters of equity growth between 2000 and 2020, from $150 trillion to $500 trillion, savings and investment accounted for just 28% of the rise in balance sheets.

If we consider that investments in infrastructure, industrial equipment, machinery and intangible assets are what really drives productivity and innovation, we are facing bad news. With the exception of China and Japan, non-real estate assets now account for a lower proportion of total assets in the 10 countries surveyed compared to 20 years ago. Furthermore, despite the fact that digital transactions and the flow of information have grown exponentially over the period, intangible assets account for just 4% of equity.

This can happen, as the authors note, because “for their owners, usually large companies, the assumption is that the value of intangible assets drops rapidly due to obsolescence and competition, even though their value to society may be longer lasting”. This is all a numbers game. The study points out that if amortization depreciation were removed from the valuation of intangible assets over the past 20 years, their value would quadruple (which could in fact justify the seemingly unsustainable rise in the value of certain technology stocks).

Still, as much as people talk about blockchain, cryptocurrencies, and big data, it’s quite surprising that, in the 21st century, wealth still resides in the oldest asset category: bricks and mortar. What lesson should we draw from this? For starters, it seems increasingly clear that low interest rates haven’t done much for business investment. Second, and a little more encouraging, the big government spending programs of the post-Covid era present a new opportunity to try to drive money into more productive sectors that can realign wealth and growth.

Third, affordable housing is the most pressing economic issue right now. The mobility provided by technology and the increasing flexibility of work in the post-pandemic era may alleviate some of the pressure. More likely, we will need to rethink urban zoning and encourage higher density, as California has already done. We will also have to find ways to tax real estate based on some form of capital appreciation but also taking into account income so as not to penalize retirees. Only when we fix the housing situation will we be able to rebalance the world’s accounts.