Housing bubbles everywhere
Posted by Frugal on March 5th, 2010
I thought that what happened in US since 2007 (and in Japan back in 1990) would have taught people some lessons. But human greed knows no bound. Either they don’t read news, or they’re too greedy. There are still booming undying bubbles in China, Taiwan, Canada, Australia.
It is apparent that most participants recognize the value of housing investment in protecting assets against inflation. It has been the preferred financial instrument, especially in Asian culture, to buy real estate because
1. It won’t go to zero, because it’s “real” estate, and you will always have it.
2. It pays out dividends in the form of rent.
3. It always “goes up” in the long term.
My colleague asked me whether I know how much real estate has gone up since 50 to 60 years ago. He told me it’s tens of thousands of percents. Well, but one must recognize the fact that since 1930, $US has depreciated 94% in buying power, according to government official statistics (and probably worse if using unofficial figures). The primary reason that real estate goes up in the long term is because of general inflation. Since a couple of decades ago, another factor that helps real estate price is that the financing costs/interest rates have been going down. However, over the long term, the average real estate prices cannot exceed inflation rate by too much and/or for too long. Why? If real estate simply returns 1% more every year than the general inflation, after 100 years, real estate price will be 270% higher than the general wages. After 200 years, real estate price will be 732% higher than the general wages. Well, the economic law of supply and demand will always balance things out. Eventually, either people cannot afford homes anymore, and younger generation stops forming families, resulting in reduction or stagnation in population, and therefore reducing demands for homes, or the home prices will simply FALL behind the general inflation rate. And I can bet you that it will happen before real estate prices are 732% higher than the general inflation rate. In fact, both Japan and Taiwan are already showing such signs of either declining population or stagnant growth. If you have so much money that you don’t need to worry about future, housing, employment, etc, and you have all the leisure time in the world, won’t you tend to have children? On the other hand, the opposite extreme scenario would probably be true also. So if the population is declining, who is going to fill up the existing housing space, not to mention that builders will always build more. Imagining a hypothetical scenario, where for every grand kid, he or she is inheriting at least 2 homes from both sides of the grandparents, and/or parents, and/or any unmarried relatives who have passed away, now won’t the housing and/or rent price go down because there are extra supplies versus demands? Of course, before long, economic law of supply and demand will kick in, and population would have increased.
What I’m trying to point out is that it is simply IMPOSSIBLE for housing prices to stay higher than inflation rates for too long. Those that bet on housing prices will increase 10% above inflation rate every year are simply delusional.
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March 5th, 2010 at 7:22 am
There has been piles of talk lately about Canada having a bubble that’s near collapse but I’m not so convinced it will play out the same as it has in the USA. There are two pretty major differences in the way mortgages work here, in that they are not non-recourse mortgages and you must be qualified on the 5 year fixed term no matter what outlandish financing options you are taking (previously it was 3 if I’m remembering correctly). There was also a recent change to down payment requirements on non-owner occupied properties in order to ease off the speculators.
Sure we’ve had some periods of large growth lately thanks to the insanely low interest rates, and that rate has to slow eventually for the average of inflation to be sustained, but to see a nation wide collapse is not as likely . . . not impossible though.
Also, that link you put in is from 2008.
March 5th, 2010 at 6:58 pm
I don’t think it’s greed on the part of brokers, or the real estate companies. It’s the governments behind them. I think China plans on dumping the negatives of their bubble into the U.S. economy in the upcoming months. Watch the Dow hit 8000 this year.
March 6th, 2010 at 8:52 am
And in the 1950’s you could have bought real estate in the thriving town of Detroit. Today many of those houses are effectively worth zero.
March 8th, 2010 at 12:54 pm
@Traciatim: I hear Canadians justify the lofty prices all the time now, which is similar to what many in the US did before the bubble burst. It all comes down to incomes. When housing breaches a healthy ratio of income to mortgage then a price decline is coming. Maybe it won’t be as widespread as the US, but the cities in Canada are certainly looking like a bubble. Look at your own fellow citizen Dave Rosenburg. He discusses Canadian real estate and sees bubbles in the cities. The less populated areas may be fine, just as they are in the US. No bubble in North Dakota or Wyoming.
March 13th, 2010 at 10:25 pm
While I do not disagree with the thesis in the post (and, in particular, do agree that housing prices cannot rise much faster than inflation indefinitely), I am far from convinced that the analysis is that simple. For example, I have some problems with the statistic that housing is 732% higher than general wages over 200 years:
1. do we know for a fact that housing prices and general wages were “correctly” aligned 200 years ago (whatever “correctly” means in this context)? If house prices were relatively depressed at the time or general wages were relatively inflated then the 732% may be misleading
2. general wages is not the best benchmark for comparison. Owner occupied housing is to a certain extent a luxury rather than a necessity. Although I have no evidence to support my theory, I would expect that it would be more relevant to compare the gains in the excess of general wages above basic living costs (food, clothing) than general wages taken as a whole. If general wages rise faster than the basic cost of living then housing actually becomes more afordable even if it is rising faster than general wages as a whole. A related point is that general wages is the wage of an individual – not the income of a household. The emergence of two income families is not reflected in the comparison and, in developed markets, has been a huge factor since the 1960s
3. housing is driven by a lot of factors, of which general wages is only one. Dempographics, credit supply and planning restrictions all have a big influence on housing prices
4. housing is also driven by local factors – the Detroit example given above is a good one. What is happening in a number of emerging markets is also interesting – the emergence of a growing and increasingly affluent middle class, increased availability of credit and improving legal rights are driving housing price increases
5. final point: how accurately have housing prices and general wages been measured over the last 200 years?
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