What happens to equities as property prices soften?
Changes in property prices can influence the broader economy and corporate earnings, helping to explain potential impacts on sharemarkets.
This article from Shani Jayamanne originally appeared in the ASX’s Investor Update.
Australians tend to think of the property market as tangible – it is bricks and mortar you can see, feel, touch. The share market in comparison feels like a nebulous concept that exists in the ether.
In reality, there is a connection.
Residential property is Australia’s largest asset class, worth around $12.7 trillion according to the Australian Bureau of Statistics, and changes in house prices ripple through an interconnected economy. A struggling property market doesn’t just affect homeowners looking to sell, it can influence consumer spending, company profits, interest rate expectations and ultimately, share prices.
Why falling property prices matter
The biggest link between housing and the sharemarket isn’t direct. It’s confidence.
Economists refer to this as the wealth effect. When households see the value of their home rise, they tend to feel more financially secure and spend more.
Reserve Bank of Australia research suggests households spend around 2–3 cents of every additional dollar they gain in housing wealth. This sounds negligible but when the value of housing is $12.7 trillion and 67% of Australians own their homes the housing market’s impact on spending matters.
When housing prices soften consumer spending can suffer. When house prices fall, homeowners often become more cautious, even if their income hasn’t changed and they have no plans to sell their home. People often postpone spending for renovations or going on holiday and generally cut back on discretionary spending.
This can impact company earnings tied to overall economic activity. If consumers spend less, many businesses generate lower profits, which can eventually weigh on share prices. The impact is rarely immediate, but housing is an important gauge of consumer confidence in Australia.
Are we going to see a larger move to invest in shares?
Property has delivered attractive returns in Australia, but rising prices, higher borrowing costs and the upfront capital required to buy a property have made it increasingly difficult for some Australians to enter the market. Recent changes to the taxation of residential investment property may further reduce its after-tax appeal for some investors. This raises an obvious question: could more money flow into the sharemarket instead?
I would be cautious about making decisions based on trying to predict a large-scale shift from property into shares. For most Australians, the family home isn’t competing directly with shares for investment dollars. The decision to buy a home is driven by lifestyle and housing needs as much as investment returns, while investment property and shares have different risk, return and cashflow characteristics. Even if investment property becomes relatively less attractive, that doesn’t mean investors will automatically sell property and buy equities.
What the tax changes could do is influence where some new investment capital is directed. Shares have a lower barrier to entry and are more liquid which makes it easier to diversify, particularly through exchange traded funds (ETFs). If the after-tax return from residential investment property becomes less attractive relative to other investments, some investors may choose to direct more of their future capital towards shares.
For sharemarket investors, however, I think the more useful question is not whether money will flow from property into equities, it is what changes in the housing market could mean for the companies they own.
Housing has a significant influence on the broader economy. Falling property prices can affect household wealth and consumer spending, while lower levels of housing activity can reduce demand for mortgages and related services.
Banks, insurers, retailers and other businesses can therefore be affected by changes in housing activity, prices and borrowing. These are the fundamentals worth paying attention to rather than trying to predict whether investors will switch from one asset class to another.
Ultimately, I wouldn’t change my strategic asset allocation based on the recent property tax changes or short-term movements in house prices. The impact on the relative attractiveness of property and shares is difficult to predict, and investors are better served by focusing on their long-term goals, valuations and the fundamentals of the investments they actually own.
Which sectors feel it most?
Not every company is impacted equally by a break in momentum in the housing market. Businesses linked directly to residential construction, building materials, home furnishings, renovation activity and discretionary household spending often feel the impact first. Consumers who are feeling less wealthy are more likely to delay large purchases than everyday essentials due to the wealth effect, as discussed.
Banks are another area investors naturally focus on. Given that residential mortgages account for a large proportion of Australian banks’ loan books, falling house prices often raise concerns about loan losses. New data from OurTop10 shows that Australia has hit its highest risk of mortgage defaults in 25 years, with the sharpest quarterly uptick since records started in 2001. There’s an 18% increase in average national risk of a missed mortgage payment, with interest rate hikes looming.
Westpac has had mortgage applications reduce by 20% since the Budget announcements this year, with expectations that investor demand for home loans will halve over the next two years.
Meanwhile, sectors with less direct exposure to domestic housing such as healthcare, utilities or globally diversified technology businesses may prove more resilient if weakness in housing doesn’t spill into the broader economy. This highlights one of the key benefits of diversification. Different sectors respond differently to changing economic conditions, reducing the risk that any single trend dominates portfolio performance.
The bigger lesson for investors
Housing attracts enormous attention in Australia because it’s familiar, visible and deeply personal. We notice auction results, hear about prices from neighbours and see headlines every time the market changes direction.
The sharemarket operates differently. It reflects expectations about the future rather than today’s conditions. Share prices are a reflection of how millions of investors weigh thousands of pieces of information. Inflation, interest rates, employment, company earnings, government policy and geopolitical events all shape investor expectations simultaneously.
For long-term investors, history suggests that remaining invested through changing economic conditions has generally been more successful than attempting to predict the next move in either the property market or the sharemarket. Property prices may provide useful information about the direction of the economy, but successful investing relies on understanding the broader picture, remaining diversified and focusing on long-term fundamentals rather than short-term narratives.
