Foreign buyers and housing price dynamics

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Abstract

This paper analyzes the short- and long-run effects of foreign buyers on housing prices in an open economy with the flexible exchange-rate system. In the long run, the changes in housing prices depend on the price elasticity of foreign buyers’ housing demand, while the adjustments in the exchange rate depend on the degree of international capital mobility. Nonetheless, in the short run, the changes in housing prices and exchange rates can be over- or under-shot or mis-adjusted, dependent partly on the length of time between the policy announcement and its implementation. The housing prices could fall in the short run if foreign housing demand is price-elastic, while the exchange rates could be over-shot if capital is less mobile.

Introduction

“Land or housing is a wealth,” according to a famous Chinese proverb. Since March 2009, rapid surges of housing prices in many emerging and developed economies have attracted great attention in academics and media. As shown in Fig. 1, from 2009 to 2014, housing prices had been doubled in Hong Kong, and more than 50% higher in China, Singapore and Australia, respectively, while the top 10 cities of housing prices growth in Q4 2015 are listed in Table 1. Housing prices, similar to other commodity prices, are mainly determined by housing demand and supply. In the literature, Herring and Wachter (1999), IMF (2000), and Girouard and Blöndal (2001) examined the demand-supply factors that cause fluctuations of housing prices, while Ullah and Zhou (2003) and Grandner and Gstach (2004) analyzed the links between real estate and stock markets. A survey article on related issues can be found in Cho (1996).

It is notable that one of the forces contributed to the surging housing prices in those economies may be increasing demand from foreign buyers. In the environment of low interest rates induced by quantitative easing (QE) policies, overseas funds have continuously flooded into many economies, constantly pushing up their asset prices including housing prices. For example, as shown in Chart 1, real estate investment in 2013–2014 by foreign investors in Australia had a significant increase with 23,428 applications by A$74.6 billion, compared to 12,025 cases for A$51.9 billion in 2012–2013. Among it, proposed investment in commercial real estate increased from A$34.8 billion in 2012–2013 to A$39.9 billion in 2013–2014, while investment in residential real estate also increased from A$17.2 billion in 2012–2013 to A$34.7 billion in 2013–2014. China was the largest source of proposed approvals on real estate in Australia, with the investment of A$12.4 billion. The other major sources of proposed real estate investment were the United States (A$6.1 billion), Singapore (A$4.3 billion), Canada (A$2.9 billion), and Malaysia (A$2.0 billion).1

In Fig. 2, the latest National Australia Bank (NAB) Residential Property Survey 2015 Q1 shows that the foreign buyer participation rate in the new housing markets was 15.6% nationally. Foreign buyers rose to high of 21% in New South Wales, while fell to 20.7% in Victoria. Around 53% of foreign purchases were apartments, 30% houses and 17% for re-development. The 41% foreign buyers bought properties between A$0.5 snd 1 million, 30% for less than A$0.5 million, and 5% for buying premium properties more than A$5 million.

Recently, to curb short-term speculations in the heated housing markets, cooling measures and tightening policies, particularly on foreign buyers, have been introduced and implemented in these economies. In Hong Kong, a 15% additional buyer’s stamp duty (ABSD) has been imposed on foreign buyers on the top of buyer’s stamp duty (BSD) on 27 December 2012. Singapore also introduced a 15% BSD on 12 January 2013. Lately, foreign investors have rushed into the Australian property markets. On May 2, 2015, the Australian government announced that illegal foreign buyers face tough new penalties on housing purchases including three years’ jail and huge fines up to A$637,500. Moreover, on 25 March 2016, Shenzhen and Shanghai, two major cities in China, with annual real estate price jumps by 57 and 20 percent year-to-year respectively, announced new tightening housing measures on non-local buyers by raising the purchase threshold of local employment from 1 year to 3 years in Shenzhen and 2 years to 5 years in Shanghai. In addition, a recent UBS report (2016) indicated that housing in Vancouver, Canada has been overpriced since 2007 and the prices have gone into ‘‘overdrive’’ in the past two years due to strong demand by foreign investors. A typical detached single-family house in August 2016 was C$1.6 million, according to the Real Estate Board of Greater Vancouver, and the provincial government had to impose a 15 percent property tax on foreign buyers in an attempt to cool housing demand.

For social harmony, stabilization of housing prices is an important consideration for government. Interventions, via verbal announcements and/or actual interventions, in the housing markets have often been used to maintain stability of housing prices as well as achieve efficiency of resource allocation. In particular, verbal announcements on the housing policy, prior to actual interventions, have been a common practice in regulating asset markets. Since the seminal paper of Dornbusch (1976) by introducing expectations on exchange-rate dynamics, substantial studies have examined the effects of “anticipated” policy changes (i.e., policy announcements) on dynamic adjustments of the economy. By extending the regressive formation of expectations in Dornbusch (1976) to perfect foresight, Wilson (1979) and Gray and Turnovsky (1979) investigated the effects of policy announcements on the exchange-rate dynamics of the economy. In addition, the policy announcement effects have been applied to the changes in other financial variables, such as stock prices, commodity prices and housing prices, as in Poterba, 1984, Poterba, 1992 and Poterba, Weil, and Shiller (1991).

By incorporating the housing market into the Dornbusch’s (1976) model, the purpose of this paper is to examine the housing price movements of the policy announcement, such as a lax regulation on foreign buyers in the domestic housing market, for an economy with international capital mobility. A rise in housing demand by foreign buyers can cause the housing prices to rise and the exchange rate to appreciate in the long run, while yielding various adjustment paths on the housing prices and exchange rates in the short run, depending on the price elasticity of foreign housing demand and the degree of international capital mobility as well as on the time length between policy announcement and its implementation. In particular, the housing prices could fall in the short run if foreign housing demand is price-elastic, while the exchange rates could be over-shot if capital is less mobile. Nonetheless, in the literature, the issue of foreign buyers on price dynamics in the local housing market has been paid less attention, except for the studies by Miller, Sklarz, and Ordway (1988) and Chao and Yu (2015). The former provided evidence on a price premium of $11.11 per square foot by Japanese buyers relative to local buyers in purchasing Hawaii’s houses in 1987–1988, while the latter examined the static impacts of foreign buyers on local housing prices in a general-equilibrium setup.

The remainder of this paper is organized as follows. Section 2 sets up an analytical framework of a small open economy with a housing market, in which we follow Poterba et al. (1991) to specific housing demands based on holding costs for domestic and foreign buyers. In addition, capital is mobile between countries. Section 3 characterizes the dynamic behavior of the economy, in which the associated impacts of foreign buyers on housing prices dynamics are examined and discussed. We will show the dynamics of housing prices depend on the elasticity of foreign housing demand and the degree of capital mobility. The results can be applied to countries such as Australia, China, Malaysia and Singapore. Section 4 provides concluding remarks.

Section snippets

The model

We consider an open economy that consists of a goods market, a money market and a housing market. There are domestic and foreign buyers in the home housing market. The market participants form their expectations with perfect foresight, while capital is imperfectly mobile between countries. The economy is small in the sense that it cannot affect the foreign goods price and the world interest rate. The home economy can be described by the following equations:PC=EPC*ṖH=π[D(rPHPC)+D*(r*PHEPC*,N*)S

Dynamic adjustments of an increase in foreign buyers

We are now ready to address the dynamic adjustments of the housing price PH and the exchange rate E in response to the pre-announcement of increasing foreign buyers (N*). For expository convenience, in what follows 0 and 0+ represent the instants before and after the policy announcement, while T and T+ represent the instants before and after the policy’s implementation.

After describing the above steady-state values of PH and E, we can utilize phase diagrams to depict the dynamic paths towards

Conclusions

Property investments from overseas buyers have recently surged in many economies, and consequent debates over the impacts on local housing prices have been also sparked. Utilizing an open macroeconomic model with a housing market, this paper has examined the price responses of a rise in foreign purchases in the short and the long run for the economy. The results show that in the long run the impact of foreign buyers on housing prices depends on the price elasticity of foreign demand, while the

Acknowledgements

This paper was presented on 19th May 2016 at the IREF-Taipei “Trade, Finance and Growth” Workshop, organized by the Institute of Economics, Academia Sinica, and College of Business, Feng Chia University. The authors thank to the discussant, Hsun Chu, and an anonymous referee for valuable comments and suggestions. All remaining errors are however our own.

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