Excerpts and graph from the Economist:
MANY of the world’s financial and economic woes since 2008 began with the bursting of the biggest bubble in history. Never before had house prices risen so fast, for so long, in so many countries. Yet the bust has been much less widespread than the boom.
Home prices tumbled by 34% in America from 2006 to their low point earlier this year; in Ireland they plunged by an even more painful 45% from their peak in 2007; and prices have fallen by around 15% in Spain and Denmark. But in most other countries they have dipped by less than 10%, as in Britain and Italy. In some countries, such as Australia, Canada and Sweden, prices wobbled but then surged to new highs. As a result, many property markets are still looking uncomfortably overvalued.
Since American homes now look cheap, are prices set to rebound? Average house prices are 8% undervalued relative to rents, and 22% undervalued relative to income (see chart). Prices may have reached a floor, but this is no guarantee of an imminent bounce. In Britain and Sweden in the mid-1990s, prices undershot fair value by around 35%. Prices in Britain did not really start to rise for almost four years after they bottomed. Some 4m foreclosed homes could come onto America’s market, which may hold down prices.
The second question is whether home prices in markets that are still overvalued are likely to fall. Some economists reject our measures of overvaluation, arguing that lower interest rates justify higher prices because buyers can take out bigger mortgages. There is some truth in this, but interest rates will not always be so low. The recent jump in bond yields in some euro-area countries has raised mortgage rates for new borrowers. And low rates need to be balanced against the fact that tighter credit conditions make it harder for homebuyers to get mortgages.
Another popular argument used to justify sky-high prices in countries such as Australia and Canada is that a rising population pushes up demand. But this should raise both prices and rents, leaving their ratios unchanged.
Prices do not necessarily need to drop sharply to return to fair value. Adjustment could come through higher rents and wages. With low inflation, however, it could take a decade or more before price ratios return to their long-run average in some countries.
American prices fell sharply, even though homes were less overvalued than they were in many other countries, because high-risk mortgages and a surge in unemployment caused distressed sales. In most other countries, lenders avoided the worst excesses of subprime lending, and unemployment rose by less, so there were fewer forced sales dragging prices down. America is also unusual in having non-recourse mortgages that let borrowers walk away with no liability.
An optimist could therefore argue that our gauges overstate the extent to which house prices are overvalued, and that if markets are only a bit too expensive they can adjust gradually without a sharp fall. It is important to remember, however, that lower interest rates and rising populations were used to justify higher prices in America and Ireland before their bubbles burst so spectacularly.
Another concern is that Australia, Britain, Canada, the Netherlands, New Zealand, Spain and Sweden all have even higher household-debt burdens in relation to income than America did at the peak of its bubble. Overvalued prices and large debts leave households vulnerable to a rise in unemployment or higher mortgage rates. A credit crunch or recession could cause house prices to tumble in many more countries.
Mish’s take on this article (he likes it, but thinks that it has some holes):
http://globaleconomicanalysis.blogspot.com/2011/11/house-of-horrors-prices-falling-in-8-of.html
If you’re going to compare housing prices to rents over time, don’t you think you should at least maybe consider that RENTS ARE WAY UP. It does make a difference. A bubble in rents doesn’t necessarily mean house prices are cheap.
A realist like me would could argue that the housing bubbles of France, Belgium, Sweden, Switzerland, Canada and China have not popped yet. When they do…
There’s a lot of hot air left here in the States, too, it’s just masked by the uneven distribution of the losses.
The discount of old houses to new in South Africa is about 30% and what the economist doesnt mention is while house prices may have risen 15.6% since 2007 a litre of petrol or a bag of cement have gone up 35%.
Undervalued by 32% against income in China from the table? It’s got be kidding!
Andrewa,
I have a friend who’s from SA, and he says the large disparity in old/new house prices is largely due to build quality and amenities, and if you factor those in, there’s little difference in price.
Like Jim always says: there’s little price won’t fix (or was it “nothing price won’t fix”?, I forget)
Otherwise,
There’s some great points made here above, and I’d argue we’re at a pretty rational point throughout much of SoCal given the circumstances. I still think we’ll overshoot a bit more, but it will not be discernable in the median stats (it’ll be a mix solution)
One additional point about interest rates. From my experience (I know several owners in Germany, Ireland, and Japan), and there is a big difference in how much is to be put down when buying a house. In Germany, it’s common to have 50%, Ireland, 35% (or thereabouts), and Japan has very large dp’s as well. They also borrow at favorable rates; I know of Germany at 2% (floating), Ireland at 2.5% (also float), and 1.5% in Japan (also float).
Our concept of “fixed” rates means we pay a huge premium to borrow. We also have very small down payments (even at 20%). We also have crappy houses that need to be torn down every 40 or so years.
My point is, it’s a diverse world, and this kind of analysis should be the playthings of internet bloggers, not serious economics publications. JMHO.
Chuck Ponzi
The U.S.A is in the bargain bucket of world RE. If the U.S.A. immigration policy was the as easy say as Canada, we would be awash in Asian and south American immigrants pushing up our prices as high as they are in Canada.
@Chuck, you have made some very valid points. But Build quality? My residential house was built in 1927 and if you put a steel straight edge on the ceramic tiling in the kitchen you cannot fit a business card between it and any of the tiles. On a newly built (8 years old) insurance repair in my one bathroom you could fit a cigarette ( the amount of fighting that went on with insurance companys and assesors to get the same standard of workmanship performed in the bathroom was almost unbelievable)
@Jiji, very true. In my country the number of immigrants and border jumpers has dropped only 25%-30% since the end of apartheid and the constant supply of skilled ones certainly helps to keep house prices up (supply and demand). Bearing in mind that due to Xenophobia in South Africa sometimes foreigners are burnt to death by the locals nowadays border jumping is a risky enterprise.
+1 to Jiji.
I am a first generation immigrant myself and know plenty of folks in the old-country who would like to move to US; if immigration policies are relaxed a bit.
But then again immigration is a double edged sword and should be planned and exercised carefully.
For US, immigration is perhaps our biggest (and most underplayed) competitive advantage over BRIC and rest of the world. It has the potential to change the Globalization Game in favor of US Main Street … only if we play this card correctly.
Andrewa,
I think he was referring more to the quality of materials used in the build. There are much better quality materials available in construction today than there were even 30 years ago.
I know as a practical matter that any house with cast iron waste pipes (the only option more than 30 years ago) are a ticking time bomb. And single pane windows vs dual glazed argon-filled low-e variety as well as HVAC, modern pipe fittings, electrical wires and reformed codes, etc. New homes don’t have the problem of every schmuck trying to tinker with the house and making things worse or dangerous.
Alternatively, if you take an old house down to the base building materials and replace everything not seen (all major systems) as well as what is seen, and I’m confident that you’ll be able to sell it close to the same price as a new house. At least, that’s what my friend confirmed.
I don’t know, I’m just trying to reconcile the incongruity if your strongly held belief with the rationality of my friend’s belief. It would be interesting to know why people would react the way you describe. Any thoughts? Superstition?
Chuck
Chuck/Andrewa:
Build quality was generally very poor between ~1945 and fairly recently. Of course, there are exceptions, as PLENTY of newer stuff is just shamefully badly built.
Depending on the area, older homes often trade at a premium. But that doesn’t apply much to CA because “older” usually means it was built during the above-mentioned period. That ain’t old. Look at the 1920s stuff in Santa Barabara, etc. Nice!