An interesting by product of a buoyant real estate market is a phenomenon called the wealth effect.

You hear it used by economists as a term to explain favourable economic data, particularly in regard to consumer spending and it usually always coincides with rising house prices.

The premise is quite simple. As property owners see the value of their main asset (their home) rise in value, they feel wealthier and therefore more inclined to be more comfortable to spend more of their hard earned cash.

When we go to buy any discretionary item (an item that we want but don’t need) we usually go through two distinct phases. We go through the emotional attachment phase and then we go through the justification of purchase phase in our minds. In other words, we are initially attracted to the item but then ask ourselves questions like, “Can I afford it?” “Is the price right?” and “Will I use it?”

The wealth effect premise is that we are more likely to say yes to those questions when we feel wealthier and we feel wealthier when we see our house going up in value. Whether we feel that consciously or unconsciously, the data supports the premise that consumer spending rises as house prices rise.

Real estate values are often seen as a barometer for the health of an economy and home ownership is a widely held aspiration in Australia. Approximately two thirds of Australian households own a home, approximately half with a mortgage and half without. The governments of Australia provide regular incentives (particular to first home buyers) to assist them with the purchase of their first home as they understand the benefits of home ownership on the economy and general wellbeing.

This is obviously where rising house prices are a double-edged sword. On one side you have one section of the population feeling wealthier and another section feeling like their dream is getting harder to attain. Although frustrating for those seeking home ownership, the upside is that those that feel wealthier do spend more as house prices rise and there are positive flow on effects for everyone from this.