For US housing, the great Chinese buying spree is over, or so it seems, for now.
After years of headlines heralding a surge of foreign investment in the United States, the trade war has finally taken its toll. Cross-border flows are retreating. In real estate in particular, Chinese investors are selling big holdings.
Not all countries are heading for the exits, mind you. (In fact, foreign purchases are near an all-time high.) But with interest rates rising and government officials scrutinising outbound investment more closely, it’s not surprising to see China receding in the rankings.
The question is, after years of blaming foreign investors for nosebleed prices, should the United States now brace itself for an abrupt return to affordability?
US housing markets and the effect of foreign investment
According to my calculations, the relationship simply doesn’t work that way. In a recent expert comment for the Dialogue of Civilizations Research Institute, I estimated the effect of foreign investment on local US real estate markets, and what I found doesn’t look anything like the scare stories that you might have heard in today’s increasingly nationalist public debate.
Local US housing prices have been more positively correlated with foreign stock markets in the post-2011 recovery period but even this isn’t alarming
Some of the concern is understandable. Foreign investment increases the demand for real estate, driving up prices at a time when many cities are experiencing severe affordability crises. Foreign investors tend to be ‘high net worth individuals’ (HNWIs) who invest in high-priced properties, exacerbating the inequality gap between neighbourhoods. The market then can become dependent on these risky capital flows, exposing it to destabilising fluctuations of inflows and outflows.
When times are good, of course, the fiscal stimulus can be beneficial. Recent research by Christian A.L. Hilber and Olivier Schöni reveals that policymakers in Switzerland actually increased unemployment when they prohibited HNWIs from building second homes. These HNWIs, in turn, receive diversification for their portfolios when they invest abroad, as well as a safe haven from the instability of their home countries.
If the HNWIs don’t plan to live in these investment properties, however, the vacant homes take up valuable space that local residents may need amid the housing shortage in large US cities. It’s worth investigating, therefore, whether foreign markets are having a significant effect on this local affordability problem.
Cause and effect in the US housing market
The trouble, from a researcher’s standpoint, is the fact that causation runs in both directions. How do we know that foreign investment led to higher prices—and not that the expectation of higher prices attracted investors?
I avoid this conundrum by measuring the effect of foreign stock markets, rather than foreign investment. It’s pretty hard to argue that the housing prices in Los Angeles are somehow driving the Chinese stock market, but it’s not so hard to believe that the Chinese stock market affects the decisions of Chinese investors, who in turn play a role in LA’s housing market. The causation only goes in one direction.
But it’s not obvious what that effect looks like. When China’s stock market goes up, do investors send more or less money abroad? On the one hand, they’re wealthier, so they can afford to invest more in US real estate. On the other hand, they might not want to invest overseas when their own economy is offering such high returns. Economists call this the ‘opportunity cost’—the alternative opportunity they lose out on by investing in US real estate.
Foreign HNWIs only account for about 1 percent of the $800 billion that’s invested annually in US housing
I weigh this ‘opportunity cost’ channel against the former ‘wealth effect’ channel by studying the effect of stock markets for the three largest foreign investors in US real estate—Canada, China, and Germany—on the three largest US destinations: LA, Miami, and New York City.
First, I run a ‘cointegration test’, which measures whether there has been a long-term linear relationship—a change in one market’s prices is associated with a change in the other’s—that can’t be explained simply by the previous price changes in each market. In the case of China, the answer is yes. Germany and Canada, in contrast, aren’t cointegrated with most US cities.
Second, I run a ‘vector error correction model’, which uses this linear relationship, along with the previous prices in each market, to show how local US housing prices tend to react to an increase in each foreign stock market. The model reveals very little effect. When there is an effect, it is mostly negative. The opportunity-cost channel therefore appears stronger than the wealth-effect channel, but neither channel is enough to make local US real estate markets significantly dependent on foreign economies.
You might still be concerned if you think this dependency is a recent phenomenon, not a long-term relationship. It is true, according to my calculations, that local US housing prices have been more positively correlated with these foreign stock markets in the post-2011 recovery period than during the previous boom or bust.
Even this finding isn’t as alarming, though, as it might seem. Of all the countries, China actually has the lowest correlation, suggesting that the correlations don’t reflect the effect detected by the vector error correction model; rather, it’s more likely that all large economies have simply become more financially integrated and therefore more synchronised in recent years. The model asked whether foreign markets are affecting local housing prices after controlling for these common trends across the global economy.
These global trends are the real story, but it’s not surprising to see people mistake them for a concerted effort to target their city, where they see it playing out. Most local residents are probably overestimating the prevalence of what’s new and different. In fact, foreign HNWIs only account for about 1 percent of the $800 billion that’s invested annually in US housing. It’s simply too small to explain any meaningful swings in most cities.
That doesn’t mean that foreign investment doesn’t matter. It may not affect cities as a whole, but there are definitely neighbourhood-level submarkets where it is more concentrated than 1 percent. Urban planners still need to account for this influx of demand when trying to address displacement and the strain on infrastructure, and financial regulators need to keep a watchful eye on the amount of leverage that this investment induces, potentially magnifying gains and losses in ways that my model cannot detect.
Even with these caveats, however, I find no evidence that foreign markets are one of the primary causes of the US housing affordability crisis. Rather, it is a problem of our own making, and no amount of scapegoating can erase the domestic inequities that beg our attention at this time.
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