Global House Prices - Will There Be A Bust?
by
Stuart Gray, January 2005
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Most
economists would answer “yes”. US policy
makers apparently think not, at least at home. Nonetheless,
it cannot be denied that the latest boom in house prices
has been unprecedented in both its extent and international
synchronicity, enduring even through a brief period
of economic recession in the United States.
From
1997 to 2004, house prices escalated by 116% in the
United Kingdom, 174% in Ireland, 121% in Spain, 113%
in Australia and 75% in the Netherlands. Even in the
United States, which has consistently denied the existence
of a national housing market or the growing danger of
a real estate bubble, prices have risen by 53% in the
last eight years – a boom unparalleled at any
time since the end of the Second World War.
Despite
a growing body of opinion which states that this trend
is ultimately unsustainable, it has only been very recently
that some markets have shown signs of cooling. Indeed,
between 2003 and 2004, some countries saw the strongest
gains in average prices yet. According to the quarterly
global house price indices compiled by The Economist,
in the year to the end of the third quarter of 2004,
prices in South Africa underwent a record 35% increase,
while property in Hong Kong rallied 31% (although prices
here remain well below their 1997 levels). In Spain,
property values increased by 17%, the strongest in the
developed world, while the United States saw its fastest
real term year-on-year increase when house prices climbed
13% over the 12 months to the third quarter last year.
In all, average house prices rose by 10% or more in
11 of the twenty countries tracked by the index.
Nonetheless,
evidence has emerged in recently released figures to
show that markets are at last beginning to slow in certain
areas. The results of the monthly house price survey
conducted by the Nationwide Building Society, a major
British mortgage lender, revealed that prices declined
by 0.2% in December 2004 following months of sustained
increases. The same survey also showed that annual house
price inflation in 2004, at 12.7%, was at its lowest
level for three years. Evidence that house prices had
begun to drift lower at the end of 2004 was also confirmed
by the Office of the Deputy Prime Minster. According
to the ODPM survey, house prices fell by 0.1% in November
compared to October, although it noted a slight increase
in annual house price inflation.
In
Australia, the signs are more ominous. While Australia
topped The Economist’s house price index for the
majority of 2003, the Commonwealth Bank of Australia’s
index shows that prices in Sydney were 15% lower in
September 2004 than they were in December 2003. Moreover,
prices nationally had dropped by an average of 10% over
the period.
More
revealing perhaps are UK mortgage lending figures, which
reveal a marked slowdown in lending at the conclusion
of 2004. The British Bankers Association, which accounts
for two-thirds of outstanding mortgages in the UK and
70% of gross lending, reported that the total sum lent
for house purchases declined 11.8% year-on-year in November
2004. Moreover, between October and November last year
loan approvals dropped by 20%, and were 41% down on
November 2003. When the Council of Mortgage Lenders
reported that mortgage lending rose modestly in December
2004, its Director General Michael Coogan noted that
figures were “indisputably weakening” and
stated that he expected the market to continue decelerating
in 2005. Similarly, recent reports from the United States
indicate that appetite for loans is weakening despite
a drop in fixed mortgage rates to their lowest level
for several months.
The
question, therefore, is whether these latest developments
in Australia, the UK and the US are a harbinger of deeper
correction to come on a global scale.
In
an attempt to answer this we must examine the economic
fundamentals that underpin the global housing market.
The current trend has been fuelled to some extent by
a sustained period of low interest rates. Between 1990
and 2004, the average base interest rate in the United
States and its twelve main trading partners fell from
13% to 4.4%. This has been of particular significance
in the housing markets of Ireland and Spain which had
to accept a sharp drop in interest rates after entering
the European Monetary Union. Coupled with the growing
availability of credit and rising real incomes in most
industrialised countries over the last decade, plenty
of fuel has thus been provided to power demand in the
housing market across most of the developed world.
But
just as low interest rates helped to sustain house price
growth, the likelihood of higher interest rates in 2005
and beyond promises to quell the demand for credit and
take much of the steam out of the housing market. Indeed,
the short to medium term outlook signals rising interest
rates, and analysts suspect the Federal Reserve will
ratchet up the fed funds rate, currently 2.25%, by at
least 100 basis points (1%) through 2005. Moreover,
with the US government heavily in deficit, upward pressure
on rates is likely to remain in the foreseeable future.
So the question is how far and how fast they will go
up. Provided there are no major external economic shocks
in the offing, it is thought that the Fed’s preferred
course will be a gradual tightening of monetary policy
to achieve a soft landing for the housing market and
in the wider economy. However, this is by no means guaranteed.
While
higher interest rates will undoubtedly cool demand for
residential property, their impact may well be mitigated
in some markets due to country specific factors such
as the type of mortgage loans buyers hold. These can
vary widely from country to country. For instance, in
the United States most mortgages are fixed over 30 years,
meaning home buyers and the housing market should theoretically
be less sensitive to rate hikes. In some other countries,
such as the UK, mortgage rates are rarely fixed for
such a long term, and tend to float up and down with
the prevailing interest rate. Here, higher interest
rates could apply a more severe brake on demand for
lending, triggering a sharper decline in the housing
market as witnessed in the late 1980s and early 1990s.
Still,
interest rates do not tell the whole story of what is
happening in the global housing market. According to
some economists, the current boom has no basis at all
in economic fundamentals, and is being driven purely
by a similar “irrational exuberance” which
characterised the stock market bubble in the late 1990s.
In other words, houses are now being viewed increasingly
by people as a short-term money-making vehicle rather
than a mere a dwelling or long-term asset to bequeath
the next generation. Evidence of speculative activity
has been displayed in the United States, where turnover
in existing homes reached a record 9% in 2004 as buyers
and sellers in particular hotspots cashed in on spiralling
prices. This bull market mentality has meant that the
boom in house prices has been almost self sustaining
and has occurred independently of other factors such
as interest rates and rising incomes.
What’s
more, in times of rising house prices banks tend to
lend more because the collateral securing the loan is
increasing in value, further fanning the flames of a
raging market. Conversely, when home values begin falling,
banks are less keen to lend, thus accelerating the bust.
If,
as some contend, house prices have grown on the back
of a speculative bubble rather than economic fundamentals,
then it could only be a matter of time before that bubble
bursts. Indeed many economists now fear that house prices
in many jurisdictions have risen to uncomfortably high
levels in relation to incomes. Put simply, homes have
become unaffordable. Calculations by The Economist suggest
that house price to income ratios have hit record highs
in several key markets, including Australia, France,
Ireland, the Netherlands, New Zealand, Spain, The United
Kingdom and the United States. Taking the average income
to house price ratio between 1975 and 2000 as a baseline,
The Economist calculates that US house prices are presently
30% over-valued – already above levels that in
the past have proved unsustainable. The IMF in its world
economic outlook has also warned that house prices are
dangerously out of line with incomes. Its analysts suggest
that there is a tendency for markets to correct at a
rate of about 15% per year when prices and income move
this far out of line with one another.
Soaring
house prices have also had the effect of pricing out
first time buyers in many areas, particularly the UK,
where 361,000 people stepped on to the first rung of
the housing ladder last year – down from 532,000
in 2002, according to Britain’s largest mortgage
lender the Halifax. First-time buyers are an integral
component of any market, and in recent years have made
up 50% of all purchases in the UK. Worryingly, they
accounted for only 29% of all purchases last year.
So,
much of the evidence put forward thus far would seem
to suggest that, at the least, prices markets will cool
and house prices will plateau. At worst, markets will
correct sharply as prices move to a more sustainable
level.
However,
not all agree that a nasty shock is in store for home
owners in the months or years ahead. Fed Chief Alan
Greenspan has argued that from a US perspective, the
real estate market tends to be highly localised, and
does not suffer from the same irrational exuberance
as in the UK or Australia for example. To an extent,
this is true. As of March 2004, ratios of incomes to
house prices in Mid-Western states such as Illinois,
Wisconsin and Kentucky ranged from 2.4 to 1 to 2.9 to
1, whereas in California the ratios were nearer 8.5
to 1 (meaning the average house price is 8.5 times higher
than the average income of a Californian household).
Nevertheless, recent research highlighted evidence of
property market bubbles in 27 metropolitan areas, mainly
in California and in the North East, covering 20% of
the total population.
In
fact, the accusation can be levelled at Greenspan and
the guardians of US economic policy that the latest
housing market boom has been encouraged to help the
American economy weather a period of relative weakness.
In each of the five years to 2003, roughly one-third
of all US home owners refinanced against the rising
value of their homes, helping to unlock some $1.6 trillion
in cash, the lion’s share of which has been spent
on big ticket consumer goods, acting as a useful prop
for the US economy.
With
house prices in many parts of the United States, and
indeed the world, clearly out of line with the economic
fundamentals underpinning the market, it remains to
be seen how Greenspan will manage the situation from
here. Whether tighter monetary policy and falling house
prices in the US would be enough to trigger a widespread
global decline in property markets is open to debate.
While there are signs of cooling in the UK and Australia,
markets continued to confound the predictions of economists
through 2004 and may well continue to do so into 2005
and beyond. Economic forecasting is rarely an exact
science, and only time will tell whether the global
property markets have had their day.
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