Are Chinese buyers affecting house prices?

Respected economist Alan Wood notes here why he believes small increases in foreign investment in the Australian real estate market will not have a tangible impact on home prices.

While it is nice to have a little calm to a situation that is sure to encourage exaggerated media spin, I’m not sure whether Wood’s claim holds - that because Chinese investors are a small percentage of buyers there will be little to no impact on prices. If we make one assumption, that Chinese buyers are willing to pay more than local and other foreign buyers, then his claim completely breaks down.

The following stories might help explain why.

Imagine an auction. In the scenario without the Chinese buyer it will sell for $500,000, which is $1,000 more than the second bidder was willing to pay, but is actually $10,000 less than the winning bidder would have paid had they needed to.

Now in the same scenario add a single Chinese buyer also willing to pay $510,000. They will bid up the price to $510,000 against the winner in the previous scenario. There is a chance they will buy it, but also a chance the winner from the previous scenario will buy with a token small bid.

So we can clearly demonstrate that 1) a single buyer entering a market willing to pay more than other potential buyers can drive up prices, and 2) these new buyers do not necessarily have to buy, simply 'bid up the market' to have an impact.

How about another scenario?

Imagine you have a train ready to leave the station. There are one hundred queues (one at each door). Each person must pay the market rate for a ticket which has been established over time to be $5. If they aren't willing to pay the market price, there are plenty of other people willing to pay the market price to take their place.

Now one of those queues (1% of the market - the Chinese buyers perhaps, maybe the first home buyers) decides they are willing to pay $6 so that their queue will move faster and they will get more seats on the train. Now, the market price moves to $6, and any other person from any other queue will have to pay $6 to get on, or let the train fill people from the Chinese/FHB queue. Some people from the remaining Aussie queues pull out, but there are still plenty who are willing to pay the $6 for their spot on the train. Indeed some even believe if they pay $6, they might be able to scalp their ticket for $7 a bit later if the price goes up again.

I believe there is no theoretical basis for the assertion that because buyers willing to pay more are small % of the market they do not impact prices.

Of course, this all rests on the assertion that the small number of Chinese buyers are in fact willing to pay more than other buyers.