Posted on 06/24/2005 10:55:45 AM PDT by Tumbleweed_Connection
The current worldwide boom in residential real estate prices is "the biggest bubble in history," according to a disturbing new report in the Economist magazine.
Never before have home prices risen so fast, for so long, in so many countries including the United State, reveals a front-page story in the world's most respected financial periodical.
"Rising property prices helped to prop up the world economy after the stock market bubble burst in 2000," The Economist reports. "What if the housing boom now turns to bust?
"Pain," the magazine says will result when the market "pops."
The figures detailing the bubble are daunting:
# The total value of residential property in developed countries rose by more than $30 trillion, to $70 trillion, over the past five years – an increase equal to the combined GDPs of those nations.
# The U.S. has experienced one of the largest increases in home prices over the past year, with the average cost of a home rising by 12.5 percent.
# In Florida, California, Nevada, Hawaii, Maryland and Washington, D.C., the average price rose more than 20 percent. And in Palm Beach County, Fla., the median price of an existing home shot up 35 percent in just the past year.
# Other countries have showed gains even higher than the U.S. in the last year, with prices rising by 23.6 percent in South Africa, 19 percent in Hong Kong and over 15 percent in Spain and France.
# A recent report by the National Association of Realtors (NAR) showed that sales of existing homes in the U.S. soared to a record high 7.18 million in April.
# But 23 percent of all American houses bought last year were for investment, not owner-occupation, showing that speculation in the real estate market is rampant. CNBC reports that in Miami, a hotbed of condominium building, an estimated 70% of condo buyers are investors/speculators, and not residents.
# Due to various new forms of riskier mortgages, 42 percent of first-time buyers – and 25 percent of all buyers – made no down payment on their home purchase last year, the NAR disclosed, making them especially vulnerable to a downturn in resale prices.
# In California, 60 percent of all new mortgages this year are interest-only or negative-amortization. These loans are gambles that prices will continue to rise.
Bigger Than the Dotcom Bubble
Noted stock investor Sir John Templeton described the 1990s tech boom as the "biggest bubble in history" before it crashed.
But that bubble appears to be superceded by the real estate boom.
The current real estate boom has seen prices go up more than 100 percent of many countries GDP -- a number that "is larger than the global stock market bubble in the late 1990s (an increase over five years of 80 percent of GDP) or America's stock market bubble in the late 1920s (55 percent of GDP)," The Economist notes.
"In other words, it looks like the biggest bubble in history."
The real estate boom in a few countries has already begun to fizzle.
According to one yardstick, average house prices have fallen by 7 percent in Australia since 2003, and in Sydney prices have tumbled by 16 percent.
Britain's real estate market has also cooled considerably. One index showed an increase of only 5.5 percent in prices during the first five months of this year, down from 20 percent growth in July 2004.
But in most countries – including the U.S. - home prices have risen since 1997 by much more in real terms (adjusting for inflation) than during any previous boom, even though for the month of May, the Commerce Department said the U.S. median sales price dropped 6.5 percent to $217,000 - perhaps the first signs of a cooling market in the U.S.
The boom in America has brought real gains more than three times larger than in previous housing booms in the 1970s and 1980s.
Great Depression Comparisons
One clear indication that residential real estate is overvalued is the relationship between home prices and rents.
The price of a home should reflect the future benefits of ownership, in the form of rental income for an investor or rent saved by an owner-occupier. When the price-to-rent ratio is high, property is overvalued.
House prices in relation to rent have hit all-time highs in the U.S., Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium.
In the U.S., the ratio is 35 percent above its 1975-2000 average. A drop in home prices is more likely today than after previous booms for three reasons, according to The Economist: Homes are more overvalued, inflation is much lower and many more people have been buying homes as an investment.
If prices begin to level off or drop, as they did in May, owner-occupiers will likely remain in their homes, but investors are more apt to sell, particularly if rents don't cover interest payments. That will increase the supply of homes for sale and further depress the market.
Also, residential real estate investment in the U.S. is at a 40-year high, while the number of households is growing at its slowest pace in 40 years. This is bound to create excess supply.
"With prices looking overvalued in more states than ever in the past, average American prices may well fall for the first time since the Great Depression," according to The Economist.
And a rebound in the real estate market could take some time – when British home prices fell in the early 1990s, a decade passed before they returned to their previous peak, after adjusting for inflation.
Economy Will be Socked
Another troubling aspect is the effect a real estate downturn could have on the economy in general. Even a leveling of prices can lead to a sharp slowdown in consumer spending.
Consumer spending and residential construction have accounted for 90 percent of the total growth in the American GDP over the last four years, and more than 40 percent of all private-sector jobs created since 2001 have been in housing-related sectors, including construction and mortgage brokering.
The International Monetary Fund analyzed home prices in a number of countries from 1970 to 2001, and found 20 "busts" – when real prices fell by almost 30 percent. All but one of those busts led to a recession.
Japanese property prices have fallen for 14 years in a row, by 40 percent from their peak in 1991, and consumer spending has been weak, leading The Economist to conclude, "Americans who believe that house prices can only go up and pose no risk to their economy would be well advised to look overseas."
A builder friend reports that a shortage of approved building lots explains most of our price increases. Although a portion of the "blame" should be given to larger home sizes and more elaborate "finishes", such as marble bathroom and granite countertops.
I was interested to hear that he is most worried about a "bubble" in Houston. This is because, with limited governmental contol over the number of "permitted units" in that market, an "oversupply" situation actually could develop.
It seems to me that in large areas of the country, where people have not refinanced themselves into oblivion (which seems stupid to me anyway), things will be just fine despite the dip in prices.
And it would allow prices to come down and more people to get better/traditional mortgages. Am I missing something?
Quote: One clear indication that residential real estate is overvalued is the relationship between home prices and rents.
CAn't remember the talk show guy from florida but his rule of thumb was that the monthly rent should be 1% of the value of the property.
My sister and BIL live out side of washington. They rent because he's in the milutary. The rent is $2700 per month. The landlord say his mortgage payment $3500 not counting taxes or upkeep.
We just cashed out of the VA suburbs of D.C. Our rent is $2000 a month and there are 2 empty (brand new) homes next door for $600K and $650K. The financing fell through one one. Don't know the story about the other one.
It will be epic. There will be a third Homeric Epic. They will find Homer's remains, get his DNA, and clone him just to write it.
mark
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