Real estate dominates global balance sheets

McKinsey Global Institute has released a new report entitled, The rise and rise of the global balance sheet, which shows that the market value of the world’s balance sheet tripled in the first two decades of this century, driven by real estate.

Below is the summary of this report:

While the state of economies is usually measured by GDP or other metrics of economic flows, this research examines the balance sheets of ten countries representing more than 60 percent of global income: Australia, Canada, China, France, Germany, Japan, Mexico, Sweden, the United Kingdom, and the United States. This view highlights a dual paradox: bricks and mortar make up most of net worth, even as economies turn digital and intangible, and balance sheets have expanded rapidly over the past two decades, even as economic growth has been tepid. How countries and companies adjust to this divergence between wealth and GDP, find 21st-century stores of value, and address growing financial imbalances will determine the future course of the global economy and our wealth.

The market value of the global balance sheet tripled in the first two decades of this century. Each of its three components — real assets and net worth; financial assets and liabilities held by households, governments, and nonfinancial corporations; and financial assets and liabilities held by financial corporations — grew from about $150 trillion in 2000, or about 4 times GDP, to about $500 trillion, or about 6 times GDP in 2020.

The world has never been wealthier, with large variations across countries, sectors, and households. Net worth is the store of value that determines wealth and supports the generation of future income. At the consolidated global level, it is equivalent to the value of real assets because all financial assets are matched by corresponding liabilities so that they net out. Net worth tripled between 2000 and 2020 to $510 trillion, or 6.1 times global GDP, with China accounting for one-third of global growth. Households are the final owners of 95 percent of net worth, half in the form of real assets, mostly housing, and the rest in financial assets such as equity, deposits, and pension funds. Net worth per capita ranged from $46,000 in Mexico to $351,000 in Australia in our sample. In China and the United States, the top 10 percent of households owned two-thirds of wealth.

Two-thirds of global net worth is stored in real estate and only about 20 percent in other fixed assets, raising questions about whether societies store their wealth productively. The value of residential real estate amounted to almost half of global net worth in 2020, while corporate and government buildings and land accounted for an additional 20 percent. Assets that drive much of economic growth—infrastructure, industrial structures, machinery and equipment, intangibles—as well as inventories and mineral reserves make up the rest. Except in China and Japan, non-real estate assets made up a lower share of total real assets than in 2000. Despite the rise of digitization, intangibles are just 4 percent of net worth: they typically lose value to competition and commoditization, with notable exceptions. Our analysis does not address nonmarket stores of value such as human or natural capital.

Asset values are now nearly 50 percent higher than the long-run average relative to income. Net worth and GDP historically moved in sync at the global level, with country-specific deviations followed by corrections, as in Japan in 1990. However, in the countries in our sample, net worth in 2020 was nearly 50 percent higher relative to income than the long-run average between 1970 and 1999. Asset price increases above inflation propelled by low interest rates drove this divergence, while saving and investment accounted for only 28 percent of net worth growth. In 2000–20, annual post-inflation valuation gains quadrupled compared with earlier decades and almost caught up with the returns from the operation of assets, which declined.

For every $1 in net new investment, the global economy created almost $2 in new debt. Financial assets and liabilities held outside the financial sector grew much faster than GDP, and at an average of 3.7 times cumulative net investment between 2000 and 2020. As asset prices rose, economywide loan-to-value (LTV) ratios, which compare debt to produced assets, remained constant at about 80 percent on average, but exceeded 100 percent in Canada, Japan, and the United Kingdom. While the cost of debt declined sharply relative to GDP,  thanks to lower interest rates, high LTV ratios raise questions about financial exposure and how the financial sector allocates capital to investment.

How may the future unfold, and what can economic actors do? We see three potential scenarios: (1) a new paradigm in which the value of assets relative to income is higher, in part because of demographic changes and a higher propensity to save among high-income  households; (2) a mean reversion in asset prices; and (3) a rebalancing of the balance sheet relative to income from faster GDP growth as investment and productivity growth accelerate along with inflation. Households, corporates, financial institutions, and policy makers could assess and stress test the impact of those scenarios on their own balance sheets, find markers for how the economy will evolve, and hedge downsides while benefiting from upsides. Growing out of any potential imbalance would require all economic actors to redirect capital into productive and growth-enhancing investments such as sustainability, affordable housing, digital infrastructure, and yetto-be-discovered 21st-century stores of value for savers.

Data released last year by the ABS showed that the majority of Australia’s wealth growth has been driven by real estate:

In fact, when divided by Australia’s estimated resident population, Australia’s dwelling stock owned by households was worth nearly $350,000 per head of population in the September quarter, well above the $250,000 of financial assets owned by households:

Household wealth per capita

My view is that having so much wealth locked up in housing is useless. We all need somewhere to live and higher home values serve little purpose to the vast majority of owner-occupiers, who typically must sell and buy into the same market.

Expensive housing also punishes those who have recently entered, or are yet to enter, the housing market. These people are required to either take-out mega-mortgages and have a life of debt slavery, or miss-out altogether.

Would Australians really be worse-off if the median capital city dwelling price was $375,000 instead of $750,000, mortgage debt was 70% of disposable incomes instead of 140%, and the banking sector was smaller and less profitable?

The answer is obviously no. Lower debt loads would make Australian households better-off, whereas the broader economy would benefit from the productivity-boosting effects of lower land prices, increased business lending (investment), and a more balanced economy.

Unconventional Economist

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