House of cards -- Housing Market Outlook and Commentary

The Economist.com ^ | 5/29/03 | Pam Woodall

[arete]

Housing is just as prone to irrational exuberance as is the stockmarket. Property is increasingly viewed as an easy way to make money. People buy a home in the expectation that its price will continue to rise strongly over time. Such expectations lie at the heart of all bubbles. Given the boom in the property market over the past few years, at the very least house-buyers betting on further rapid house-price gains are likely to be disappointed. Worse, there is a risk that house prices will take such a tumble that they take whole economies with them.

This survey will conclude that the latest housing boom has inflated bubbles in several countries, notably America, Australia, Britain, Ireland, the Netherlands and Spain. Within the next year or so those bubbles are likely to burst, leading to falls in average real house prices of 15-20% in America and 30% or more elsewhere over the next few years, in line with average price declines during past housing-market busts.

Mortgage rates are still falling but I doubt that trend can continue for much longer. One more year of the refi and new home boom?

Richard W.

[arete]

FYI

Comments and opinions welcome.

Richard W.

[dogbyte12]

Housing in L.A. is starting to cool off. I have a co-worker who is trying to sell her house for $350k, which she could have easily gotten 2 years ago, in a matter of days... it has been 3 months now and not even a semi serious offer.

I am renting a house at the moment for a reasonable rate. I couldn't fathom paying the market rate. My house would literally sell for close to $325k and it is only 1250 square feet.

I could afford to buy it, but I can't stomach it. It is great for people who invested at the right time, but I am wondering if there are other people like me, who say... gee, I can buy a tiny house in LA for a third of a million, or get myself land and a giant house elsewhere, and still have some change left.

[Southack]

This article is clearly satire. No one at the Economist can misunderstand economics so badly as to make the claims above, without intending them to be humor, anyway.

But for those who don't get it, housing prices are determined by SUPPLY AND DEMAND, not by interest rates or high paying jobs.

There are plenty of high-priced homes in Moscow, Beijing, and Tehran where there are no good-paying jobs, and there are high-priced homes in places and times where interest rates are high, too.

Thus, the *reason* home values increase or decrease is NOT due to interest rates or jobs, but due to supply and demand.

Families will move in and live on top of one another before they'll let the right house get away, regardless of how high-priced it might be.

[backhoe]

Richard, I recall my Dad telling me how you could build a new, 2-bedroom, one bath house ( a starter home for a small family ) for $7,000 right at the close of WWII. And its value depreciated thereafter- it was a "used" home...

Rats, gotta run- wife & dog are bugging me...

[razorback-bert]

People buy a home ( stocks, beanie babies, tulip bulbs) in the expectation that its price will continue to rise strongly over time. Such expectations lie at the heart of all bubbles

[evaporation-plus]

When interest rates go up it is likely the bubble will pop......
I think the carnage will be much greater than when the air was let out of the stock
market bubble. In addition, we will see how much of the past economic activity was due to refinancing and cash outs.

[arete]

I think the carnage will be much greater than when the air was let out of the stock

It is going to get really ugly. Too many people doing cash outs and playing with artificially high home prices like they were a checking account. They are going to be stuck with more debt and a declining asset value.

Richard W.

[galt-jw]

I think a bust is likely. I have felt this way for a while. It is like anything else: too much activity has driven up the price past realistic valuation. I would be interested in picking up some cheap land with a low interest rate loan when the prices fall. Time it, just like the stock market. God bless Bob Brinker.

[the gillman@blacklagoon.com]

Faith in the future is what fuels demand.

If housing goes, so goes the nation.

It's Real Estate. Always capitalized.

[galt-jw]

I was just thinking about beanie babies, too. what an idiot identification exercise that was.

[the gillman@blacklagoon.com]

The world has changed.

Before the tax reform of 86, Real Estate always had the best tax breaks. I took it as the government abandoning the nation with that particular act.

The present housing buble is just the last flights of desperation and fancy.

Our present system can not be maintained.

[jscd3]

But for those who don't get it, housing prices are determined by SUPPLY AND DEMAND, not by interest rates or high paying jobs.

Uh, dude..."Supply" and "Demand" are simply shorthand terms for describing the tradeoffs made at a variety of price levels for any good or service. If the "price" of something (the cost in terms of what you have to give up to get it, also called the opportunity cost)goes down, all other things being equal, the quantity of that thing demanded (in the short run) and possibly, the demand for that thing (in the long run) increases. The reverse when "price" (the cost of the next best alternative use of your resources) goes up.

When the federal govt follows a "low interest" policy, either through direct subsidized intervention in the market (think FreddyMac or FannyMae) or via monetary policy, or indirectly through tax policy (think mortgage deduction), it reduces the cost of capital associated with certain long term aquisitions below that which would exist in a voluntary "free" market. By doing this, it lowers the opportunity cost associated with the purchase of long term or capital assets - like housing. Since the stock of housing is, at any specific point in time relatively fixed, this reduction in opportunity cost will result in an increase in quantity demanded, which will translate into higher prices.

If intervention were not continuous, we might expect an expansion in the supply of housing to result in prices returning to a lower level. But, in the US, intervention has been continuous for many years, generally leading to higher prices and higher supplies than would otherwise exist. Moreover, in some markets (like San Fran, for example) a combination of limited land and excrutiating regulations dramatically limits the ability of the housing stock to expand at all, greatly exacerbating the problem.

I hope that my crummy spelling doesn't get in the way of this clearing up some things. Thank You.

[Southack]

"When the federal govt follows a "low interest" policy, either through direct subsidized intervention in the market (think FreddyMac or FannyMae) or via monetary policy, or indirectly through tax policy (think mortgage deduction), it reduces the cost of capital associated with certain long term aquisitions below that which would exist in a voluntary "free" market. By doing this, it lowers the opportunity cost associated with the purchase of long term or capital assets - like housing. Since the stock of housing is, at any specific point in time relatively fixed, this reduction in opportunity cost will result in an increase in quantity demanded, which will translate into higher prices."

That sounds great, but if interest rates were the sole cause of supply and demand, then we would have had HIGHER home prices back in the 1960's when interest rates were as low or lower than they are today.

Moreover, your theory doesn't explain why housing prices went UP along with interest rates in the 1970's.

In short, that's not how the world works. Nice try though.

You can have HIGH housing prices in areas with truly crummy jobs (e.g. Tehran, Moscow, and Beijing). You can have HIGH housing prices when interest rates are high (e.g. the 1970's), too.

Neither interest rates nor jobs explains the high prices for real estate in San Francisco and Hong Kong.

But "supply and demand" does explain it.

You want to see where real estate prices have dropped? Look for nations that have stagnant or declining populations (e.g. Germany, Japan).

Now, if you want to see where home prices go up, then simply look at areas that are expanding in population.

On the other hand, if your theory can't explain the 1960's and 1970's real estate markets, then why believe it?

[arete]

God bless Bob Brinker

What has old Brinker been saying lately?

Richard W.

[Southack]

"The present housing buble is just the last flights of desperation and fancy. Our present system can not be maintained."

Nonsense. First of all, we don't even have a national "housing bubble". Bubbles are caused by speculation. There aren't significant numbers of people speculating in houses. Instead, people are buying a home and then, gasp, living in it!

Second, our population is expanding. It's one thing for housing to decline in price when you have a declining population (witness the ghost towns of the Old West in the 1800's), but quite another to claim that housing prices will come down when there are more people being born than homes being built.

Third, we have a new corporate dynamic that hasn't even been considered by the hedge fund gloomsters: tax-free dividends.

What do dividends have to do with real-estate, you ask?

Well, one of the largest groups of dividend paying stocks are REITs. For the uninformed, REITs are Real-Estate Investment Trusts. These are companies that buy real estate, operate some form of business (such as leasing office space) with the real-estate, and then pass the profits (or more than 90% of the profits, at least) all back to the shareholders in the form of dividends.

But as of today, dividends are now exempt from 50% of income taxes, and as of next year, they will be completely tax free. This means that *shareholders* of REITs and other dividend-paying companies are about to see their investments rise, as their after-tax income from these stocks has just ballooned with the stroke of a pen (thank you, President Bush)!

So what does that have to do with real-estate? Well, for starters it means that REITs are going to have an easier time raising money for guess what, MORE real estate purchases.

Sure, we're only looking at a trickle here in 2003, but come 2004 this trickle will be a more respectable stream, and that means that there will be new money chasing real-estate across this great nation.

Tax free income. It's now spelled D I V I D E N D S!

[who_would_fardels_bear]

If house prices get so high that either a person has to choose between mortgaging themselves to the brink of economic collapse or commuting for hours, then they can make other choices. For example, they can move to another city or they can live in an apartment, or they can share space with someone else.

So even if the overall number of people in a given area increases, house prices do not necessarily need to follow.

House prices collapsed in the L.A. area back in the mid-90's even though there was still a net increase in people moving into the state (despite the large number of people leaving.)

If it was a choice between one family in one house or homelessness, then your argument would be entirely valid. But there are a myriad of other choices which could act to dampen the demand on home buying.

[Katya]

Well not to burst your bubble...but I bought a house at the end of the last bubble, paid a premium price and sold it 12 years later for almost double. When a so-called bubble bursts, it just means demand has slowed. The only people who get screwed are those who need a short term sale, particularly if they bought a newly built house. I can't recall a single time where a house that suffered initial price deflation, did not recoup all of its value plus over a ten year period.

[Dog Gone]

But as of today, dividends are now exempt from 50% of income taxes, and as of next year, they will be completely tax free.

Did I miss a detail in the new tax plan? I thought dividends were going to be taxed at a 15% rate (which is still a substantial improvement), and that the tax-free concept was killed in conference committee.

[TomSmedley]

Hey, virtuous!

Here in the RTP area of NC, I see a lot of commercial and residential construction going on. I also see a lot of "Space for lease" signs on vacant commercial properties. A lot of empty parking lots.

I'm reminded of Heinlein's novel Door Into Summer where the protagonist gets a job destroying brand new cars built to soak up increased monetary supply.

Inflated money has to go somewhere. For a while it inflated the dot-com bubble. And now?