There's a kind of interesting way to think about this, especially in the UK. Because people don't automatically think in terms of opportunity cost and don't know eg. that the long term equity return is X, there's a disconnect between reality and how people think of it.
People in the UK think of rent as "wasted" money. In an efficient market, it wouldn't be wasted at all because the saving from lower rent vs mortgage could be put into eg. equity/bonds. Someone will reply that there is no saving but that itself is a symptom of the way we run housing.
But because people think that, and think that no-one would ever want to rent, we tolerate super weird policies like a residency house being exempt from capital gains tax, poor protection for renters, government tax transfers (in the UK they will literally give you money to buy your first house, the government is so committed to the your-house-is-your-bank philosophy).
All these distortions then actually CREATE the conditions which mean that you're consistently losing money if you rent, because the government is effectively taxing you much more.
So our misunderstanding of economics creates an economic system which conforms to our mistaken beliefs, it's kind of amazing.
When people talk about the opportunity cost of buying, they very rarely take into account leverage. A typical house buyer might have somewhere between 2 and 9x leverage on their deposit (ie a 66-90% loan to value). Once you take that into account the returns, even if you don't take into account capital appreciation (essentially the saved cost of renting minus maintenance costs) rise significantly, becoming competitive with the long term returns on an index fund. Nobody's going to lend you significant money to invest in an index fund at anywhere close to mortgage rates.
As an example, a flat which costs £400k might have a rental value of £1.4k/month, or 4.6% annually. However, if you bought that flat with a 75% LTV at an interest rate of 2% you'd have invested £100k and have an effective return of £16800/year less £6k/year of interest. That means an annual return of 10.8%. The long term S&P 500 average return is around 12.11%[1]
It doesn't take much price inflation to tip you into better returns than the index fund. House prices since 1952 have risen by an average of 7.9%[2].
I find it distinctly odd that arguably the central organizing feature of the British economy and culture is a massive state-sanctioned pyramid scheme, which as the author points out, is wrecking Britain, as populist governments invesnt ever more ludicrous tricks to inflate prices further to win political support.
I truly wonder how the Millenial generation might disrupt this idiocy and would welcome suggestions here. So far I have thought of the possible solutions:
1. A boycott on new purchases, which would tank the market as, being a pyramid scheme (or something akin to this) it depends on new money flowing in at the base. But I see no way for a boycott to be organized - and would not want to destroy the asset wealth of those caught in ownership who would see their primary asset tank in value.
2. There is beautiful and cheap housing stock in many parts of Britain that have fallen into decline. In particular south coast towns are an example. I wonder if these areas could (a) be rejuvenated, and (b) millenials could escape housing debt traps, if they had some sort of way of signaling to each other that many like-minded people would move there. Maybe high property prices in the SE benefit from a network effect (I live in London because people like me live in London) - but new networks could be established if people signaled their commitment to new networks.
My manifesto, roughly. I've never heard of this suggestion as inflation as a remedy, but that seems a bit like chemo, quite a wide-ranging medication:
1. Replace stamp duty with a progressive wealth tax (this is the hardest one politically I think. Really you'd need coordination with other EU states, this is discussed in Capital by Picketty)
2. Light rent controls (just can't be raised by more than X% over 1 year 2 years, to prevent people getting spiked)
3. Expand renter protection - whatever the agency there currently is we triple it in size and give it teeth
4. Include all houses in capital gains, at the same rates or higher than you'd get on stocks. I guess you have a rolling exemption so that people aren't totally blindsided. This would hopefully be counterbalanced by removing stamp duty.
5. Specific tax pn land banking by builders
6. A small land value tax
7. No school catchment areas, open application and decision by ballot.
8. There have to be more details on how we change the rules about who can build what where. It's very heavily regulated (down to minimum sizes of bedrooms, amount of space for leisure etc). I dunno if the point is to remove the regulations, more like shine more light on them and maybe reconsider some of them and add others. For example, I've spent 10 years in London in rooms that were below the minimum room size allowed for new developments and so have most people that I know, so that one should be removed.
Leverage isn't free: what you gain in returns you lose in risk. For housing, this is the risk that the bank can foreclose and take the house if you miss a payment, or that you can end up underwater and trapped in a location with no jobs if the housing market declines under your equity.
You can leverage up the same with stocks, just by buying them on margin. The risks are effectively the same: if the stock declines, the bank sells it off and seizes the collateral to cover your debt. The rates are also not that different: 5.25% vs. about 4.75% for mortgages now. People are rightfully skeptical about the risks of buying stocks on margin, but they never think much of the risk of foreclosure when buying houses on mortgage.
Also a 30 year fixed mortgage effectively shorts long-term bonds with an embedded call option (via refinancing) to further reduce the risk of the position. It's an incredibly valuable consideration that's not super obvious.
Who are these people who intentionally seek a lower rent over a higher mortgage so as to invest in stocks? I've yet to meet one. Renters are just as likely to give in to vanity purchases, dumb spending habits etc...
And why are stocks such an awesome alternative? A stock can go to zero...even foreclosed homes have some value.
Stocks are optional - shelter isn't. Since you must commit some of your earnings to shelter, it makes sense over the long run to fix the costs and find a way to profit.
On a subjective level, home owners have better finances, more say in guiding their communities, and many other advantages.
Of course we can turn your argument back...why does society make so many accommodations for people who just buy and sell pieces of paper?
Take a look at the FIRE community, or anybody who is interested in a self-funded retirement.
Most people who are the ones renting and investing large amount are not buying single stocks, they are buying broad index funds that encompass the entire market and are rebalanced to keep an even representation.
These broad index funds going to zero is not a very likely scenario outside of total anarchy. It would mean all publicly traded companies becoming worthless and you would be much more worried about acquiring water, shelter, food, and protecting yourself from looters than anything else (in this scenario I would imagine the piece of paper saying your house is yours would not be worth very much either).
Now think of the much more likely scenario of a local real-estate market collapsing, uninsured natural disaster destroying your house, or climate change making your area unliveable, and you can see which proposition is really the riskier one.
If you don't sell your house you don't profit you only pay more in property taxes.
The thing is it doesn't, that's the point. If I want to rent to keep flexibility and invest my money in stocks in order to retire I am at a decided disadvantage than somebody who buys a house and has it appreciate to double its initial value. In the vast majority of countries this appreciation is free from capital gains tax, or the house's value is not taken into account in the wealth tax. So why is the house owner rewarded for saving and putting money in a mortgage and the renter penalised by capital gains/wealth taxes?
What you're saying, which is a good point, when you say that shelter isn't optional, you can phrase that more precisely as "owning property is a hedge against variable property prices". It's true but there are other ways to hedge this, eg. Long term rental contracts, limited rent controls or owning specific derivatives all reduce this risk. There are societies that run like that, eg. Germany.
Some stocks can go to zero, some are very unlikely to and most portfolios have things that are very unlikely to flatline like govt bonds.
Well i don't mortgage although i could, and I do save so hello you've met your first. The idea that we need a bank threatening to throw us out of our houses to enforce responsible saving is infantile and grotesque.
General criticism of the finance sector is a bit too off topic for me to engage with.
"owning property is a hedge against variable property prices"
One of the best pieces of financial advice that I've ever heard centers on this. "The purpose of owning a house is to fix the cost of housing." Its brilliant in its simplicity and I had never thought about it until hearing it a few dozen times. :)
Unfortunately, it is also a vastly different mindset from many home buyers (and, for various reasons, sellers).
Homes can go to zero. Homes can go to below zero, which is why there are land banks all across the Rust Belt with thousands of properties they have trouble giving away.
> On a subjective level, home owners have better finances, more say in guiding their communities, and many other advantages.
Of course, because we live in a society in which nearly everyone is convinced that it's better to own a house, so anybody with enough resources to own a house chooses to own a house. And because most of those folks have an even dimmer view of apartment-dwellers than you've displayed here, they use zoning to literally separate themselves from those lower classes, to fairly predictable outcomes.
> Homes can go to zero. Homes can go to below zero, which is why there are land banks all across the Rust Belt with thousands of properties they have trouble giving away.
Could you give some reference(s) on this? I'd love to see a bank that was trying to give away property, and to find out why they couldn't (and to see if I could find a way where the property would have positive value to me).
The LRA usually ends up with these properties when they fail to receive any bids at the regular tax auctions. Fewer are falling into their hands, recently, because the hot housing market is driving folks to look at things they previously wouldn't have, but properties still routinely go unwanted:
> A stock can go to zero...even foreclosed homes have some value.
It's possible for a foreclosed home to have negative value, because the unpaid property tax bill is more than the value of the property. On the other hand, a total stock market index fund like VTSAX can only go to zero it something catastrophic happened.
>in the UK they will literally give you money to buy your first house, the government is so committed to the your-house-is-your-bank philosophy
No wonder, banks were lobbying the state for generations. House is a purchase like any other, having to pay your tax money for somebody's else default on his McMansion is stupid.
I myself have zero reservations about renting till I kick the bucket. My dumbest decision in life was to listen to parents who were coaxing me day and night for a few years into buying a house in my hellhole hometown in Russia with like 75% of my lifetime savings. Yes, I spent ~$80k just to make my parents to fuck off. That was when I was 23, in 2014.
To some extend, I admit, the decision had in part an intention to teach them a lesson, of what a disservice they were making me with their "expert advise," but I could not have imagined just how wrong the things can go...
Wow! First, is Vladivostok that bad to be called "a hellhole" (that is, if you're referring to it, of course), and second, if it was only to make your parents shut up, couldn't you somehow done it with much, much less (say, a village house somewhere)?
It is true that housing prices in urban areas have risen astronomically in many regions of the world, and while we may well see a correction, I wonder if these these areas have simply become way more valuable than they used to be.
People thought that the internet would make location irrelevant, but it seems that the opposite has happened. I can think of many armchair theories as to why, but it's not a simple question to answer.
> It is true that housing prices in urban areas have risen astronomically in many regions of the world, and while we may well see a correction, I wonder if these these areas have simply become way more valuable than they used to be.
They are, in the short-term. The problem is that high housing costs have a slow, long-term corrosive effect on a city. Companies have to pay higher wages for workers to achieve the same standard of living, which makes them less competitive. So, for example, you see a lot of tech companies springing up in Austin now. It doesn't happen overnight, but it happens.
It also creates a large net transfer of wealth out of the city whenever someone moves. Someone who moves in with half a million dollars in net assets would normally be a boon because they would go use that money to patronize local businesses, but now they have to spend that and a good chunk of their salary going forward on housing, which goes to the seller who is moving out of the city and taking the money with them.
The housing ratchet is also completely unsustainable. The people who already own real estate want prices to increase rather than decrease to justify the high price they already paid and generate a competitive return on that huge amount of money, but when housing is already the majority expenditure for city residents, costs long-term can't increase faster than wages, and the higher wages get for the same standard of living the less competitive local companies are.
Eventually you reach a limit on how high housing costs can sustainably go, but once you hit it, nobody wants to put down a million dollars for a house that won't appreciate at all when they could be getting some ROI on the same money in the stock market. Then prices finally start to decline, but people definitely don't want to pay $950K for a house that will lose value, so the decline is rapid. This is, of course, catastrophic.
It's almost impossible to avoid this once the values are already ridiculous, but what the article suggests can mitigate it somewhat: Sustained moderate inflation combined with a large increase in the housing supply, so that real values come down even though nominal values are stable. Then the crash is in real value rather than nominal value, so people don't end up with underwater mortgages, and it can ideally happen over a period of a decade or so rather than instantaneously in a way that causes a local economic crisis.
I think for most folks actually living in these high cost areas, capital appreciation is not the primary motivation.
Also I disagree that they are universally destructive - how else do you explain the long term success of high price cities such as London, New York City, Hong Kong, etc.
> I think for most folks actually living in these high cost areas, capital appreciation is not the primary motivation.
Sure, they want a house so they can live in it. But who wants to pay a million dollars, which you either have to pay interest on (if borrowed) or can't collect interest on (if not), when it's only going to be worth the same amount of money in 30 years? At 5% interest, the lack of equivalent appreciation more than quadruples the opportunity cost of buying the house over the course of 30 years. It changes what they're willing to pay.
> Also I disagree that they are universally destructive - how else do you explain the long term success of high price cities such as London, New York City, Hong Kong, etc.
It has always been the case that some cities are more expensive than others, but that's not what we're talking about. Nor are we talking about small affluent sections like Manhattan. If you look at, say, Brooklyn, it was historically affordable to ordinary people (and 20 minutes from Manhattan). That's what's changed.
And there's no way housing in San Francisco isn't a massive bubble. It's hard to predict how long it will be before the crash, but it's obvious that it's not sustainable.
> But who wants to pay a million dollars, which you either have to pay interest on (if borrowed) or can't collect interest on (if not), when it's only going to be worth the same amount of money in 30 years?
People who want to live somewhere?
House prices tend to be what people can afford to live. People tend to budget x% of their household income on housing. With lower interest rates, it means houses are more expensive. With two full time workers it means houses are more expensive. With higher wages it means houses are more expensive.
Since 1990 house prices (in real terms) in the US have increased about 15%, but disposable household income has increased nearer 80%. Even in SF from 1990 to 2016 house prices only increased about 80% in real terms, and I suspect that average household income has increased far more
Are you comparing inflation adjusted house prices against unadjusted income?
The % of take home pay people are putting, on average, in to housing here in the UK (ok, different economy) has gone from something like 20-25% in the 1950s to something like 40-50% now.
I myself live in London and put 47% of my take home pay in to rent. That's without property related tax. I'm in the top 5% of earners in the land and can only afford a modest ~45sqm apartment. If my rent goes up next year and my income stays the same, I will have to consider a longer commute.
Nope. But these are averages, London is extreme. My mortgage in Cheshire costs 25% of my takehome pay (not the household takehome pay) - and half of that is paying off the capital. That's on a 4 bed semi.
Two earners on median £27k take home about £44k. 25% would be £900 a month, which is more than enough to rent a house.
Regional house prices are correlated with regional demand which correlate with regional job opportunities. I could go live in the sticks but then I'd struggle to find work. I moved to London because I couldn't find satisfying opportunities in the South East, 25 miles outside of London, let alone in the suburbs of Leeds. If I hadn't moved to London my 10 hour work day would have become 12-13 hours, including a nasty rush hour commute, and I would still have been paying £500/month in transport for the privilege and a high rent.
The problem here is that salaries don't scale in a linear fashion with regional property prices. In places like London, where quality property supply is low, rents are set to the absolute maximum, while still filling tenancies, and salaries, just as else where, are set to the bare minimum to fulfill demand. The result is rent as a % of take-home is maximized.
There are only three solutions. Lower property prices and rents (more housing supply), higher salaries and/or a more regionally distributed job market.
Don't get me wrong, i'm not bitching. I'm comfortable. But when people hear what you earn, and you can see by the way they react that they think you're a rich git, they just don't see these realities.
They said that about Australia 15 years ago and the heat in the market is only just coming off.
Housing prices aren't just going up in San Francisco. It's the entire Bay Area. In the last collapse, houses in "good" locations didn't lose any value. There was a pause for a couple of years (or in cities like Palo Alto, none at all) and then they started going back up again. Other cities, e.g. Alameda (http://rereport.com/alc/charts/a_all_sfr.png), suffered losses of over 50%.
> They said that about Australia 15 years ago and the heat in the market is only just coming off.
It is absolutely true that housing bubbles can span decades. But the longer they grow, the bigger the pop. Unless you deflate them first by increasing supply.
> In the last collapse, houses in "good" locations didn't lose any value.
The last collapse wasn't caused by the same things. What happened then is that banks loaned money to people who couldn't pay it back, which inflated housing prices until they started to default. The people who live in Palo Alto had better credit, didn't default, and could still get a loan even after the crisis (or didn't need one), so the houses in that area didn't lose value.
What's happening in this case is that housing in some areas is getting so expensive that even people making six figures can barely afford it. When it gets to the point that they actually can't afford it, the high end status of the neighborhood won't save them.
And a crash doesn't have to result in cheap housing. It can be a move from preposterously expensive housing to "only" very expensive housing. But if that's a 50% reduction in value, people are going to be unhappy.
> also I said they're not "universally" destructive, which I stand by, so long as some affordable housing options remain.
You may be right that if you consider only the most expensive houses, they may not lose as much value, because they're the ones that are actually worth ten million dollars. But non-universality is a small consolation if the effect still hits 85% of the local housing stock.
I think we can agree to disagree given the subjectiveness of what we're evaluating. But I will completely disagree that I'm only considering "the most expensive houses". Relatively expensive houses, sure, but in the average (or median), not absurd.
Also, I want to point out that it was an anecdotal article asserting broad outcomes. I don't think you can be so reductive about the current housing market.
> I think for most folks actually living in these high cost areas, capital appreciation is not the primary motivation.
It's somewhat subconscious. Why pay $3000 rent when you can pay a $5000 mortgage when you and all your friends agree that the house purchase is a great thing? The average buyer isn't seeking capital appreciation, but they are confident that the house is a good purchase.
Just curious, are you in the area? It's anecdotal, but the folks I know here who are buying tend to do it because they are either sick of the landlord/tenant dynamic, or because of their family. In addition (also very anecdotal, but N of >10) the ones I know who are buying for investment are usually more focused on solid rental cashflow rather than capital appreciation (although it of course still factors into the purchase decision).
Hi, yes, in the area. I hear from friends who buy (also very anecdotal). It seemed to me that people generally saved heavily toward a downpayment, then bought when they could (i.e. not worrying about how leveraged they were or what the rent/buy calculators said).
Interesting that the investment buyers are looking for cash flow; I didn't like the numbers (4 cap!?). But maybe if you have enough $$ that rate is fine.
Capital appreciation is certainly a large motivation for those who already own homes there, and those who are involved in local legislation tend to be mostly from that group.
Can you give a couple examples of this happening? I've lived in NYC much of my life and housing prices have continued to rise for most of 30+ years, so your statement isn't something that I quite understand from experience.
NYC suffers from two distinct factors that have allowed it to sustain such a long boom in real estate prices.
As a global financial and cultural center, it has enduring appeal for outsiders and foreigners to buy housing. Very few cities have this. And since these outsiders tend to pay cash, they're hard to outbid. This can distort the market a lot, because wealthy people get pushed down into upper middle class housing, upper middle class people get pushed down into middle class housing, and the shit rolls downhill until the poor can't afford to live anywhere.
The other thing is that New York had really bad lows in the housing market in the 70s, to the point where people were burning down buildings because the insurance money was worth more than the property value. It's hard to go anywhere from there except up.
> It's almost impossible to avoid this once the values are already ridiculous, but what the article suggests can mitigate it somewhat: Sustained moderate inflation combined with a large increase in the housing supply, so that real values come down even though nominal values are stable.
I'm having trouble understanding what inflation means in this context.
From the article:
> There is a way out, but it’s not a pleasant one. The economically unpleasant period of the mid-1970s, when GDP fell sharply and inflation rose to 25%, was relatively short-lived, largely because the inflation bailed out the housing market, which had already become overblown in 1973. Only a similar but more prolonged period of inflation, which will depress real house prices even as nominal house prices decline less, bailing out the mortgage market, will enable the British economy to avoid the truly disastrous situation of mass mortgage default.
> Provided the inflation takes place as required, the young will manage to navigate this situation successfully. They will be able to negotiate salary increases, as we were in the 1970s, so that their living standards keep up, more or less, although they may feel pinched. The declining real value of homes will bring more and more possible house purchases into their view, although they may find the landscape very short of mortgage lenders. Since the period of price decline is only beginning, the luckiest will be those too young to have got themselves on the housing ladder at inflated prices, not the silly Millennials, but post-Millennials.
If we're speaking about price inflation, isn't that literally what a massive housing bubble is, the mother of all price inflation scenarios (setting aside the fact that government statisticians cook the books in various ways in order to show shelter costs are perfectly inline with other prices, completely regardless of what prices are really doing, because it's abnormal)?
And if we're speaking about monetary inflation,well, where did all the money come from in the first place to make housing so expensive? Yes I know, when one house sells in a neighborhood or city everything is revalued, but when you've been at it for 10++ years and have had significant turnover of the entire inventory, this excuse begins to run thin after a while. If GDP growth is more or less flat, and there isn't negative growth in other areas like consumer spending, where is all the money coming from to execute the transactions?
Is anyone aware of any articles that try to mathematically reconcile this on a macro basis, because it makes completely no sense to me. At least in Canada it appears to be almost pure magic that at most will only take a periodic breather before the relentless upward march resumes (see the slight dip during the 2008 global meltdown, the devastating crash in oil prices that only caused a flatline in oil-rich Calgary, or real estate capital gains in Vancouver being larger than earned income). As silly as it sounds, I am starting to believe that we're somehow mis-measuring something fundamental somewhere in the system, and that this time really is different. If it isn't, then how can this be quantitatively explained? Sure, it's easy to handwave it away with "the market can stay irrational longer than you can stay solvent", but can one reconcile that with the actual reported numbers? Does what's happening add up?
The money has come, both directly and indirectly, from global capital markets. Countries like China, Russia, Germany, and Japan save a lot of money, and would like to put it somewhere where it'll be a productive investment earning interest. If Canadian property looks attractive for that purpose, some of that money will head in that direction.
> And if we're speaking about monetary inflation,well, where did all the money come from in the first place to make housing so expensive? Yes I know, when one house sells in a neighborhood or city everything is revalued, but when you've been at it for 10++ years and have had significant turnover of the entire inventory, this excuse begins to run thin after a while. If GDP growth is more or less flat, and there isn't negative growth in other areas like consumer spending, where is all the money coming from to execute the transactions?
I've struggled with a similar question. Where does the money come from? The US GDP has increased ~500x (unadjusted for inflation) in the last 100 years, this means each dollar has to be transacted 500x more frequently on average than it did 100 years ago (assuming a fixed supply). How does this work?
I don't completely understand it either though, say you cut one blade of my grass and I pay you $20, then I cut one blade of your grass and you pay me $20, rinse repeat and you get massive GDP, but no increase in wealth. Now do something similar with housing, except this time print a whole bunch of money and pour it all into housing (including construction), and compare that to a country that instead invests into education and building manufacturing plants - who is going to be wealthier?
I think this is all far more complicated than governments let on, or maybe they actually don't even understand it all, from what I can tell a large number of economists don't, so perhaps it's no surprise we're in the situations we are.
I believe the author is referring to high inflation as measured by things that reserve banks look at (in Australia this would be the consumer price index etc); while house prices either stay stagnant or rise slower than said rate of inflation.
Thus, the nominal price of housing is maintained, while the real value tanks.
How this might happened is something I do not have the economics to know - as you mentioned, an increase in the supply of money would probably simply flood into the existing housing market, overheating it further. Arguably, that's what's happened in Australia post 2008 and the US pre-2008.
> I believe the author is referring to high inflation as measured by things that reserve banks look at (in Australia this would be the consumer price index etc); while house prices either stay stagnant or rise slower than said rate of inflation. Thus, the nominal price of housing is maintained, while the real value tanks.
Yes, this makes perfect sense in theory - housing inflation has dramatically outpaced everything else, so if the government causes a whole bunch of monetary inflation by printing money and that money doesn't go into housing but goes into other things (maybe even wages!), then it will let those prices catch up, while also devaluing the cost of the housing debt.
But I think printing money is what got us into this situation in the first place, it just mostly all went into housing, to stop that from continuing you'd need to change the collective beliefs of nearly the entire population. This is one thing that could genuinely be "different this time": the belief that real estate always goes up. And you can hardly blame people, because it's more or less true, and is virtually guaranteed by more than one government policy.
Most housing doesn't face the demand part of supply and demand in the purchase price. The demand curve is set by the monthly payment. The relation between monthly payment and total price is controlled by the interest rate.
So if interest rates rise, home prices have to drop (or at least not rise) until wages rise.
Unfortunately, this doesn't actually help, because it doesn't lower peoples' monthly payments...
Housing markets are only overheated if supply is not keeping up. There are scenarios where an overheated market leads to oversupply of housing; but there is a few years' lag between investing in construction and the units coming online due to the time it takes to finance and construct housing.
> Housing markets are only(!) overheated if supply is not keeping up.
Would this imply that there was a tulip shortage in Holland in the 1630's, or am I being excessively pedantic and should have assumed a prefix of "In the long run...."?
Or another way of putting it is: is there evidence that all markets are perfectly balanced at all times, always and everywhere? Is the market perfectly rational, or do various ratios sometimes vary for no mathematically obvious reason?
If supply were able to keep up with demand, then the tulip price could've stayed the same. Of course, we live in the real world, where you can only ramp up production of good so quickly. But no one said the demand is rational.
There are places which manage to build housing without massive price appreciation, like Tokyo. But once the market's too overheated because of supply mismatch you basically can't cool it down only using construction, because construction time takes so long.
If the demand isn't rational (for example, actual need for physical shelter), it doesn't require a lack of supply for a market to become overheated.
Markets can be very strongly affected by greed and mass delusion, an actual lack of supply is not required to drive prices up significantly. You could have a fun pedantic argument over that last statement if you don't want to differentiate on the different kinds of demand, but my point is that demand can vary dramatically with little change in underlying fundamentals - human emotion is more than enough.
I think it would be very wrong to think of increasing house prices as a direct reflection of intrinsic value.
In the UK the economic model of the past forty years has been based on a conscious policy of asset price inflation. Thatcher stripped away most of the social housing in this country and put it into the market. Few have been built since. The recentering of the economy in financial services has led to a massive expansion of easy credit, that reaches its fulcrum in the housing market. Together this has meant: (a) a dwindling housing stock; (b) progressively larger sums of credit chasing the same number of properties.
That is not to mention the fact the since the late 1960s London has been the main global waystation for offshore tax havens, much of which is attached to property sales in the capital. There are 100,000 properties in the UK which are held as investments, unoccupied.
There are actually two economies - one where everything is an investment to be sweated for returns, and one where everything is priced according to real world utility.
In a financialised system everything is priced according to the values of the first economy, which are completely divorced from conventional economic utility.
This makes everything unaffordable to those who don't have access to that economy. It also lowers the quality of goods and services within the second economy, because providing quality and value conflicts with fast high returns.
Great post, worth noting that the marketing of the destruction of social housing as "right to buy" was a work of evil genius, and the citizens who know the most about it are people whose parents made a killing from it and are unsurprisingly very happy with the policy.
Catchment areas for schools are also a significant factor, mandatory ballots for school entry would make a massive difference but our government has been going in precisely the opposite direction, privatising the education system and leading to an expulsion crisis which is having knock on effects in crime.
Also London specifically is one of the lowest density major capital cities, the centre is often old and beautiful but we could stand to build a bit higher.
There's supply/demand - as some area becomes more popular more people want to move there. If you're not building new homes in the area at a rate that at the very least matches both the migration rate and the birth rate housing price is only going to increase. (People in SF fighting against tech folk also seem to fight new properties, ignoring that simply having children in SF means you necessarily must build more homes, maybe just a bit slower)
The thing that makes it worse is when taxable property values trail actual property values - it makes simply holding on to property a tax payer subsidized investment. CA for instance has capped taxable property valuations at 2%, which is a subsidy for empty properties, properties that increase rent/lease by more than 2% a year, and business (which never sell property) - the biggest component of civic services is fundamentally the cost of rent/mortgage, as that dictates how much all civic servants (emergency services, city/county administration, elected officials) need as there /base/ income. It also indirectly costs tax payers through the increased need for housing and other financial support for low income people (which can actually be a double tax, as it may result in tax payers paying rent on a property that is underpaying taxes anyway).
I think there's a lot of merit to this. The Internet has not made location irrelevant, because many other things still make location relevant. Drawing only from my own list of preferences, there are things like climate, proximity to family, access to outdoor activities, culture, social outlets, crime rate, the transportation system, and so forth.
One thing surprises me about this article: It prescribes Inflation as the antidote to land/RE prices... But that was not the case necessary for Japan.
And on the other hand they didn't highlight the role international investment in RE has had on local markets. It plays a significant role in many of the major international cities where foreign entities are allowed to buy RE as investment properties.
> I wonder if these these areas have simply become way more valuable than they used to be.
It will self correct once companies realize that by using middle managers with a modicum of domain expertise enables people to work remotely and not have to be at work for 8 hours just so their managers can visually check their presence for the contractually agreed amount of time.
A good start is to look at the interest rate curve (cost of borrowing money has gone down dramatically). Here is the US Fed Funds Rate since the early 80's:
I think you don't quite understand how things work. 5G may be efficient but the exploitable bandwidth is still limited. In cities the density of cellular mobile communications antennae is higher which leads to a reduced areas covered by a tower in which subscribers have to share the bandwidth with others. Also, in cities as opposed to rural areas, even when the bandwidth is shared, the users of a given area are often just transient. The conclusion is that the urban network quality is different from the rural one and that it (unfortunately) adds up as another reason to flock to a city.
He is talking about inflation as a way to resolve it, but my personal (and totally unscientific) pet theory is that inflation is already here. The prices are so high not because the real estate is expensive, but because the intrinsic value of money is declining. How come elevated inflation is not reflected in official stats? The problem with counting inflation is that it doesn't account for the loss of quality which is happening in all areas except high-technology products. E.g. while the price (in real money) for a burger in McDonalds can be more or less the same as in the 90s or 60s, the quality went down due to excessive use of herbicides and drugs in farming.
No wonder many people get debts because it's the right strategy when money are losing value. If the real inflation is say 5%, then getting a mortgage at 3.5% earns you 1.5% a year. No wonder stock indexes are record high nowadays -- it's not because businesses excel more than ever, it's because the dollar is worth less.
My guess would be that the intrinsic value of gold is declining as it has no much use outside of manufacturing and jewelry. Gold itself is a complex market heavily influenced by regulations and a few players. But I'm in no way an expert in it.
The intrinsic value of gold is set by manufacturing and jewelry; it has not changed much. The investment value of gold is (primarily) set by two things: the need for an inflation hedge, and speculation. Speculation is pretty much dead at the moment (nobody's buying gold because they think gold is going to go up). And gold's use as an inflation hedge is declining, because people are less worried about inflation than they were.
Why were people more worried about inflation recently? Because they thought that QE was going to cause a ton of inflation. As it now looks like the Fed will be able to unwind all of that without triggering mass inflation, people see less need for gold than they did, say, five years ago.
Real estate bubbles rarely burst unless there is accompanying unemployment. The reason is psychological, people hate realizing a loss.
Another practical reason is that if borrow $1 million for a house, and it is now worth $800,000 you just keep paying off the mortgage and hope prices go up again. Selling it would require you pay in some cash to pay off the loan. All this is provided you keep you job and can afford the loan.
The faster a bicycle goes, the more stable it is and therefore less likely to fall over. But also when it does fall over, the damage is much more devastating.
You're right that there's a keel keeping real estate from tipping. The reason isn't just psychological (although there is a strong sentimental sense of attachment you have to your house); real estate is also less liquid than almost everything else. Other factors, including proximity to work, children's schools, etc. make it a last resort in terms of liquidating. You're right -- as long as someone can keep up the mortgage payments, they'll do so.
The problem is that the bigger the bubble, the more unlikely someone can maintain those payments if suddenly unemployed or underemployed. The crash of 2008 wasn't so much averted as postponed. Subprime mortgages became 'nonprime mortgages'. The practices are still there. The artificially low interest rates are still there. The bicycle is going a thousand miles an hour and when it really crashes, look out.
> The crash of 2008 wasn't so much averted as postponed.
This.
The US housing market correction from 2006 was 30%. In this time, the US Fed funds rate went from 5.25% to 0.15% cutting banks' monthly cost for a $250k loan from >$1k/m to <$50/m.
In the meanwhile, median LTV has gone from 80% in 2007 to 95% in 2017 [1] and median loan sizes have gone from $175k to $325k. What happens when interest rates normalise and mortgage interest doubles?
The banks have been propped up but the risks have not left the system.
But the Fed cannot just arbitrarily set rates, presumably? There is some "real" rate in the economy, which is determined by supply/demand of capital at different maturities. If the Fed goes significantly below or above that, you should get price inflation or deflation.
Some people argue that interest rates are objectively low because we are in secular stagnation - there are loads of savings, but real economy growth is sluggish which means there are few investment opportunities, leading to low interest rates (e.g. https://www.morganstanley.com/pub/content/dam/msdotcom/ideas... - may not be the best link, I have seen the ideas elsewhere).
> But the Fed cannot just arbitrarily set rates, presumably?
They absolutely can, by quantitative easing (aka large-scale asset purchases) buying $4 trillion of bonds priced to keep yields in range. This market can remain irrational longer than anyone can remain solvent.
By price-fixing this market they stimulate liquidity. Institutions (such as pensions) that would normally buy safe bonds are forced to invest elsewhere at marginal yields (ie. corporate bonds and MBS). Other, more risky, investors chase growth stocks with marginal yields.
> you should get price inflation or deflation.
Indeed there has been, though currently visible only through asset prices such as bonds, stocks, securities and housing. Who can complain?
The danger comes when the tide goes out and yields go up [1]. All that extra liquidity washes from assets into yields, thereby driving inflation on produce.
[1] And up yields must, to determine how much have been swimming naked.
> Real estate bubbles rarely burst unless there is accompanying unemployment. The reason is psychological, people hate realizing a loss.
Real estate bubbles generally burst when buy side gets squeezed. It doesn't matter if people sell homes and realize losses. The bursting of bubbles isn't a supply or sell side issue. It's a demand or buy side issue.
But there are many ways the demand side can be squeezed. The most prominent is increasing interest rates. Then there is unemployment as you noted during economic downturns. There are also legal methods - draconian anti-buyer laws. Imagine if a law was passed that banned sale of homes to foreigners and even gave foreigners 3 months to divest all property in X market. Not only would that burst the bubble, it would crash the housing market.
Bubbles form when the demand side is artificially increased while limiting supply side. For example, if you granted citizenship to foreigners if they buy a house. That would spike the demand for homes but the supply of homes wouldn't increase as quickly.
There are a myriad of reasons why bubbles form and why bubbles burst. Ultimately it's the manipulation of supply and demand sides which causes one or the other.
As a resident of a more rural area that has seen a complete economic turnaround in the last few years, which seems to be attributable to people leaving the big city to find more affordable ground, the big city housing bubble is the best thing that has ever happened. It may be destructive at a local level, but I'm not sure it is universally so.
>As a resident of a more rural area that has seen a complete economic turnaround in the last few years, which seems to be attributable to people leaving the big city to find more affordable ground, the big city housing bubble is the best thing that has ever happened. It may be destructive at a local level, but I'm not sure it is universally so.
Your town is going from the "boarded up storefronts" phase to the "hardware store and Chinese take out restaurant" phase. You'll probably start considering the housing market driven gentrification destructive again when it gets to the "organic free trade hemp clothing store and bars that only serve micro-brews" phase.
That's scarily accurate. But I would say we're already in the last phase. Which is great, as it means we now have all the amenities one expects from the city, without having to live in the city.
This whole piece makes me ask what a bubble really means. The author admits to having been wrong about housing prices since 2000. But that’s okay because bubbles can, apparently, last decades. If a bubble can last a very long, but totally indeterminant amount of time, does it have any reality?
Im no economist but intuitively i would think the key piece is that they “pop”; that is, the market corrects itself ib a sudden and aggressive fashion. That its a “correction” necessitates that the valuation is divorced from its “real” value, the primary mechanic allowing this being speculation.
And ofc, since speculation and correction is always a market, the final piece of the dish is that the speculation (and thus, the eventual correction) is significantly large.
And then given that the market itself lasts long (substantially longer than decades), and that we rightfully fear, not the existence of, but the crash, then it seems fine to claim a bubble lasting decades, and even centuries.
And like all predictions of the future, there’s money to be made in the difference between its actual popping and its predicted pop, if you choose to make the bet. Ofc, money to be lost too. And if you expect it to last a century... then just make sure your grandchildren get out before it bursts (and hope it doesn’t take everything else with it). Doesn’t matter to you particularly at that time scale, but it still exists (unless ofc it corrects slowly... but hey, hindsight is 20/20)
Houses have intrinsic value, which comes from future rental cashflows. Let's ignore the premium that some people would pay over that just because they want to be owners of a house.
Then, it seems to me that house prices can be approximated as a function of rents, interest rates (determining required return on owning a house), and anticipated growth in house prices (which again can be decomposed into growth in rents, reduction in interest rates and 'irrational' growth). Using London as an example. Rental yields appear to be around 3.5% in London at the moment, which suggests to me that a good deal of anticipated growth is priced in. But where can that growth come from? Rents are a function of incomes and are unlikely to outpace inflation. Interest rates seem to be more likely to go up than down. So it seems that house prices are unlikely to rise, and once that is realized by the market, prices may even come down as participants stop anticipating growth just because "London house prices always go up".
So a bubble means that house prices are disconnected from fundamentals, that some irrational assumptions are built into the price. I am not entirely sure that there is a bubble - it seems to assume that you need to assume that there is also a sovereign debt bubble, i.e. the "risk-free rate" or the treasury yields are irrationally low. I am not sure if that is the case or not, but that is the subject for a different discussion.
I can not really give you an intuitive explanation, but economists usually refer to bubbles (or disequilibrium), when actual asset prices deviate from the prices estimated based on the identified long term equilibrium properties of often co-integrated variables.
To identify such models, VAR and SVAR (Structural Vector Autoregressive) analysis are often used, where up to 15-20 time series fed into. Such approaches of course come with their sets of necessary assumptions, but wich are in the case of VAR in levels quite reasonable...
Basically the assumption behind such kind of analysis is, that in the long run, there is some kind of equilibrium path were forces of nature/system are pushing towards to, but to identify disequilibria, you need to look at the whole system and not only 1 or two (as a ratio) variables.
An interesting application about identifying "bubbles" in housing prices with VAR you can find here [1].
It's all guesswork, right? Someone says these house prices don't make sense; someone else says they do make sense. If enough people agree that the house prices don't make sense, then the market would correct, then someone can say that really was a bubble after all.
Prices go up for some reason. That's not a bubble.
People want to buy that asset because that's where the returns are (because the price is going up). Those people drive the price up further. That's still not a bubble.
People see that the returns are really good in that asset class, so they borrow money to buy into that asset class, so a ton more money moves in, limited only by banks' willingness to lend against that asset class. Now it's a bubble.
And the problem with bubbles is not that people lose money when they pop. It's that people lose borrowed money when they pop, and if it's a big bubble, that threatens the banks, which can threaten the whole economy (not just that asset class). And, because people invested borrowed money, as the bubble starts to pop, they panic sell, which drives the price down further, which leads more people to panic sell, so the whole thing comes apart very quickly.
It's no bubble now because we don't build nearly enough in these areas. We need some kind of big federal or state project where lots of people get bought out to leave, or moved via eminent domain, and higher density built.
I'm in brisbane, australia, and this seems to be the case here as well. There has been huge increases in property values and rental returns. Recently though they're has been a high rise building boom and sure enough rental prices seem to be dropping and there's an over supply. There is a general property slow down occurring to, though how far its going to go no one knows. The supply side of the demand / supply seems to be increasing.
Another theory that seems to be going around recently is its the availability of credit that causes these bubbles, which on the face of it seems to make sense. If credit isn't available then prices wont increase, if easy cheap credit is available then people will leverage up, which pushes up house prices and the circle continues.
But because people think that, and think that no-one would ever want to rent, we tolerate super weird policies like a residency house being exempt from capital gains tax, poor protection for renters, government tax transfers (in the UK they will literally give you money to buy your first house, the government is so committed to the your-house-is-your-bank philosophy). All these distortions then actually CREATE the conditions which mean that you're consistently losing money if you rent, because the government is effectively taxing you much more.
So our misunderstanding of economics creates an economic system which conforms to our mistaken beliefs, it's kind of amazing.