How Government Spending Affects the Property Market (Part 2)

In an earlier article, we explored some of the ways in which government spending can have a positive effect upon local economies, and real estate markets. Using HMAS Stirling in Perth as a sort of case study, we also threw out a few ideas for how defence spending may be unique compared to other forms of government stimulus.

Overall, local government spending is typically a positive sign for a property market – simple.

But before you begin to anticipate growth in every region where a government is throwing money around, it’s vital to understand a few exceptions to the rule and be aware of how it can sometimes go wrong:

Crowding Out

Crowding out can be a very real danger with public spending, occurring when a government manages to inadvertently displace or ‘eliminate’ private sector investment.

Here are a few examples of how this can happen:

1. When a government borrows heavily to finance its spending, it can lead to a rise in interest rates, making borrowing more expensive for private entities.

2. A surge in government spending can increase demand for goods and services, leading to higher prices and potentially inflation, which can deter private investment.

3. In certain resource markets, government projects may directly compete with the private sector for limited resources, raising costs and hurting private investment.

Importantly, much of the outcome of government spending can depend on how the broader economy is performing at the time.

When the government decides to spend more money at a time when the economy is already doing really well, with most people having jobs, a crowding out effect is more likely. In essence, government spending in these situations can over-stimulate things. But it’s a different story if the economy isn’t doing so hot, maybe because there’s a recession going on with many people out of work and businesses not spending much. In such a case, the government stepping in to spend is more likely to be a good thing, giving the economy a much-needed boost.

The key idea is that, when the government decides to spend more, they need to find the money from somewhere. Generally, this might mean collecting more taxes or borrowing money by selling bonds and other similar things. To attract people to lend them money, they might offer higher interest rates, promising better returns for those who invest in government bonds. Due to this, companies may begin to find it more expensive to borrow money for their own investment projects, as they now must compete with attractive government offerings. In this way, the companies get “crowded out” from investment activities, finding it harder to get the money they need to grow and expand. This is why the government needs to carefully think about the state of the economy, how much to spend and where to get the money from, to make sure they are helping, not hindering.

A real-world example:

Leading up to the 2012 Olympics in London, the UK government invested heavily in the regeneration of East London, an area that had been somewhat overlooked in terms of development. The goal was not only to prepare the city for the prestigious event but also to rejuvenate this part of London and foster long-term growth.

Initially, the spending and anticipation of the event led to a significant boost in the property market. Prices in areas near the Olympic site soared as investors and homeowners alike were eager to capitalise on the buzz surrounding the event. There was a surge in demand for housing, and new developments sprouted up to accommodate this.

However, the euphoria didn’t last!

While the government’s investments did uplift the region, it inadvertently led to a crowding out effect in the surrounding areas. The government’s massive investment in infrastructure had lifted prices such that it created an affordability crisis. Furthermore, private investors found themselves competing with government projects for resources, including land and labour. This not only escalated the costs but also diverted potential investments from other fruitful projects. The rise in interest rates due to government borrowing also meant that borrowing costs for private property developers increased, making it more difficult for them to secure the necessary funds to initiate new projects or sustain ongoing ones.

In the period following the Olympics, the property market in areas surrounding the Olympic site showed some signs of stagnation. While the infrastructural upgrades were indeed state-of-the-art, the escalated property prices created a barrier for many potential buyers, thereby reducing the number of transactions. Additionally, the supply of new properties exceeded the actual demand, particularly in the case of premium accommodations which weren’t in sync with the needs of a broader segment of the population seeking more affordable options.

This led to a period where the property market had to undergo a correction phase, wherein prices stabilised and the market adapted to the new norm. Furthermore, the excess of high-end properties led to a renewed focus on developing more affordable housing options to balance the market dynamics.

It all just goes to show – public spending is often a good sign for the property market, but exercise caution. Before you commit to a market, be sure to perform your own thorough analysis or seek advice from an experienced buyers’ agent.

Want to discuss this further?

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