Wednesday, February 02, 2005

Housing bubble

I mentioned the bay area housing bubble in the last post, and was asked to elaborate. Coincidentally, the Economist just posted this survey on property worldwide.

I can't claim to be an expert on this topic, but here goes...

I think there is clear evidence for a bubble in places like the bay area, Boston, NYC, LA and some other cities. The metric I find most compelling is price to rent (P/R) ratio, which is analogous to price to earnings (P/E) for equities. This is at an all time high in many cities, although not nationwide. The other metric which is very inflated in certain markets is price to average (family) income. Some of this data is available at the Case-Shiller-Weiss (CSW) Web site. (That's Robert Shiller, of "irrational exuberance" fame.) The bay area is particularly hard to understand, since something like 250K jobs were lost since the peak of the tech bubble in 2000, and there has actually been net migration out of the area. Rents have actually dropped slightly, but property values continue to increase.

On the behavioral front, I think a lot of people jumped into real estate thinking it was one of the few "safe" investments after the stock bubble burst a few years ago. One sure sign of a bubble is that people buy with the expectation of near-term price increases. I keep reading that units in developments in places like Florida and LA are often unoccupied - the owners have purchased them as investments with the intention of flipping. These speculators are going to get burned when interest rates rise, but until then they get to brag to their friends about their big gains. (Sound familiar?)

I mentioned in a previous post that bubbles can persist for surprisingly long periods of time, even after a fairly wide consensus has emerged that things are overpriced. I claim this has a lot to do with the timescales and effectiveness of arbitrage in a particular market. See here for related discussion in the Economist, and here for derivatives related to real estate prices.

Finally, let me note that I must not be very smart, since I thought the bay area was already overpriced 10 years ago, and should have bought something back then...


Anonymous said...

As Keynes remarked about trying to time these things

"The market can stay irrational a lot longer than you can stay solvent"

Anonymous said...

U.S. Property Prices Too High? Some Funds Look Abroad

INVESTORS who worry that the American property market may be peaking have another option: putting money into real estate abroad.

Such moves have become more attractive, thanks to the export of an American form of real estate ownership, the real estate investment trust. REIT's, which generally own commercial properties like office towers, shopping malls or apartment buildings, are required to distribute most of their profits as dividends each year. Within the last four years, France, Japan and Hong Kong have allowed real estate companies to operate like American REIT's, and lawmakers in Britain and Germany are taking steps in that direction....


Anonymous said...

The development of REITs from Japan to England could have interesting effects on real estate development and prices. Japanese were only recently allowed to invest in American REITs, and money is coming in quickly though from a base of zero.


Anonymous said...

January 26, 2005

Echoes of the 80's: Japanese Return to U.S. Market
By TERRY PRISTIN - New York Times

Japanese investment in United States real estate soared in the 1980's, as companies and financial institutions poured nearly $300 billion into high-profile properties like Rockefeller Center in New York and the Pebble Beach Golf Club in California. But the value of many of these assets plunged by as much as 50 percent in the early 90's, and for more than a decade, the Japanese have been sellers rather than buyers.

After a 15-year hiatus, however, Japanese capital is re-entering the United States market, but much more quietly and cautiously this time. "They have begun to test the waters again," said Bill Collins, who runs the capital markets group at Cassidy & Pinkard, a real estate services firm in Washington....

So far, much of this Japanese money has been used to buy shares in publicly traded companies, rather than individual buildings. In October 2003, it became legal in Japan to sell portfolios of shares in real estate investment trusts, allowing special funds to be marketed specifically to Japanese investors. Some of these funds buy shares only in REIT's based in the United States, which largely own property in this country, while other funds own a portfolio of REIT shares from various countries, including the United States.


Anonymous said...

Suddenly Rich, Poor Old Ireland Seems Bewildered

DUBLIN - Between sips of caffe latte and laments about the staggering cost of property here, the Irish are beginning to ask themselves a 21st-century question: Who do we want to be, as a country, now that we have all this money?

'We are certainly in new territory,' said Joseph O'Connor, a best-selling Irish novelist who recently wrote 'Star of the Sea.' 'We haven't been here before.'

It was not so long ago, even less than a generation, that Ireland was a threadbare nation, barely relevant in European affairs. Finding a job meant hopping an airplane out of the country. People counted their pennies, not their commuter miles, and poverty, for many, was a stubborn component of Irish life.

But Ireland's jump into the European Union, along with aggressively pro-business economic policies, changed all that. In a little more than a decade, the so-called Celtic Tiger was transformed from one of the poorest countries in Western Europe to one of the richest in the world. Its gross domestic product per person, not quite 70 percent of the European Union average in 1987, sprang to 136 percent of the union's average by 2003, while the unemployment rate sank to 4 percent from 17 percent.


Anonymous said...

The American rise in real estate prices is being echoed from South Africa to Ireland to Spain and beyond. We must consider this as well.


Anonymous said...


Fearing Future, China Starts to Give Girls Their Due

ANXI, China - For farming families in the lush mountains of coastal Fujian Province, the famous crop is oolong tea and the favorite source of labor is sons. The leafy bushes of tea fill the hillsides the same way young boys fill the village streets.

There is such a glut of boys here - roughly 134 are born for every 100 girls - that the imbalance has forced an unlikely response from the Chinese government. To persuade more families to have girls, it has decided in some cases to pay families that already have daughters.

The Communist Party is often vilified for its so-called one-child policy. The government credits the policy for sharply slowing China's population growth, but critics say it is a major reason many families now use prenatal scans and selective abortions to make certain that their child is a boy....


Carson C. Chow said...

Any ideas when the bubble here in DC is going to break? The prices in Metor North West are even shocking to those in New York and the Bay.

Steve Hsu said...


See comment 1 - the quote from Keynes :^)

Anonymous said...

Condo Fever Turns Buyers Into Early Birds

ANGELINA UMANSKY, a 39-year-old spa owner from San Francisco, was visiting a friend in Miami two weeks ago when she heard about a new condo development downtown. Hoping to find a vacation home, but worried that others were interested, too, Ms. Umansky arrived at the sales office at 8 a.m. the day after seeing some model units.

About 50 other buyers were already in line. Two hours later, a sales agent summoned her and said she had four minutes to decide which unit to buy. She acted fast, offering $350,000 for a two-bedroom, two-bathroom unit.

Ms. Umansky thinks she got a bargain; when she called on behalf of a friend less than eight hours later, she was told the asking price on a unit like hers had climbed to $380,000, a nearly 9 percent price increase.

Just when it seemed as if the real estate market couldn't get any barmier, it has. With inventories lagging behind demand and prices for new homes rising seemingly by the hour in destination cities like New York and second-home markets like Miami and Orlando, home buyers are camping out overnight in front of sales offices, pestering brokers and developers and scooping up multiple units in the real estate version of scalping."This is a perfect storm for a frenzied housing market," said Susan Wachter, a professor of real estate at the Wharton School of the University of Pennsylvania. "The economy is strengthening, the restrictions on development are increasing and long-term mortgage rates are still historically low." Ms. Wachter added that as interest rates start to creep up, more buyers tend to pile into the market, trying to lock in good rates.

Across the country, according to the National Association of Home Builders, the number of new condos sold jumped 32 percent to an estimated 115,000 in 2004 compared with a year earlier. And in New York the number of condo sales in the three months through December 2004 increased 8.2 percent over the same period a year earlier, and average condo prices were up 11.1 percent to $1.29 million, according to Miller Samuel, a New York real estate appraiser....


Anonymous said...

Doug Noland continues his crusade against what he (and I) believe to be misguided US policy. His latest Credit Bubble Bulletin is titled "The Great Dilemma" and talks to the seemingly endless expansion of US credit and resultant bubbles.

"Seemingly endless" are the key words here. There will come an end to this phase of international finance, and an increasing number of economists from many different schools of thought are voicing concern.


"It is the nature of Bubbles – not unlike bureaucracies - that dynamics evolve to ensure that they are bolstered and perpetuated. Left to their own devices (which they have been), they will prove powerfully self-reinforcing; Bubbles will inflate, propagate and disperse. And I have argued that the U.S. financial sector has turned dysfunctional and that financial crisis is unfortunately the likely catalyst to contain excess and redirect the flow of resources away from asset markets and to productive investment. Today, years of mortgage lending excess incite further Credit inflation, over-consumption, excess global liquidity, a weak dollar, more central bank purchases, enticing market rates, more borrowing and speculating, deeper economic distortions, and higher home and asset prices.

"Interestingly, the GSEs have markedly slowed their expansion and attendant debt issuance. Banking system real estate lending, however, has more than filled the void. So we now have a strange dynamic where U.S. bank Credit expansion is a leading source of global liquidity that is then “recycled” directly back to U.S. securities markets. This bank Credit is created primarily through the issuance of short-term “monetary liabilities” (deposits and “repos”). The upshot is only greater supply/demand imbalance between the virtually endless supply of liquidity creation and the limited issuance of (perceived safe and liquid) longer maturity U.S. securities to be purchased by foreign central banks. This imbalance is complicated by the proliferation of variable-rate mortgages – a prime example of how financial sector 'evolution' sustains Bubbles. Here again, there is a creation of liquidity that stokes over-consumption and trade deficits that is then accumulated by Asian central banks and others - and immediately “recycled” back to a confined quantity of long-term U.S. securities.


"At this point, there remains a strong inflationary bias throughout the bond market. Each time when it appears that rates are finally commencing the much needed upward adjustment – they instead stubbornly reverse. There certainly remains a strong inflationary bias in housing prices; if rates don’t go higher, prices will. And the danger lies in the reality that this locomotive of a Credit and Asset Bubble will burst at some point. Asset prices don’t grow to the moon, and it is the final “parabolic” price rise that sets the stage. And as much as Credit excess stokes higher asset prices and only greater marketplace liquidity, the downside will also be self-reinforcing. Recall the telecom debt bust."

"The Great Dilemma is that inflating U.S. home prices have developed into the most important issue in global finance. And the tightening link between inflated American real estate prices, mispriced global finance, massive U.S. current account deficits, deteriorating government finance, a faltering dollar, endemic speculative leveraging, and deepening economic distortions is emerging as the crucial facet of latent financial fragility. The Great Dilemma is that an effort to rein in excess would begin with piercing the Mortgage Finance Bubble, something policymakers are not willing to do."

Dave Iverson

Anonymous said...

In "Global Confession Time," Morgan Stanley's Stephen Roach lays the Housing Bubble problem on the shoulders of Alan Greenspan...

Stephen Roach snippets, "Global Confession Time," 2/7/2005

"At long last, Federal Reserve Chairman Alan Greenspan has owned up to the central role he has played in sparking unprecedented global imbalances. His confession came in the form of a speech innocuously entitled, "Current Account" that was given in London at the Advancing Enterprise 2005 Conference on the eve of the 5 February G-7 meeting. In the narrow world of econo-speak, his prepared text contains the functional equivalent of a "smoking gun."

"Greenspan’s admission came when he finally made the connection between the excesses of America’s property market and its gaping current account deficit. To the best of my knowledge, this was the first time he ventured into this realm of the debate with such clarity. He starts by conceding '…the growth of home mortgage debt has been the major contributor to the decline in the personal saving rate in the United States from almost 6 percent in 1993 to its current level of 1 percent.' He then goes on to admit that the rapid growth in home mortgage debt over the past five years has been 'driven largely by equity extraction' -- jargon for the withdrawal of asset appreciation from the consumer’s largest portfolio holding, the home. In addition, the Chairman cites survey data suggesting, 'Approximately half of equity extraction shows up in additional household expenditures, reducing savings commensurately and thereby presumably contributing to the current account deficit.' In other words, he concedes that a debt-induced consumption boom has led to a massive current account deficit. That says it all, in my view.

"The obvious and most important point is that rapid growth of US mortgage debt did not come out of thin air. It was, of course, a direct outgrowth of the Fed’s hyper-accommodation of the post-bubble era -- namely, short-term interest rates that have been negative in real terms for longer than at any point since the 1970s. As Greenspan’s dryly notes, 'The fall in US interest rates since the early 1980s has supported home price increases.' That’s putting it mildly. Suffice it to say, were it not for the Fed’s aggressive monetary accommodation -- especially the post-bubble easing of some 550 bps in 2001-03 -- the home mortgage refinancing cycle would have been in a very different state. But it wasn’t just lower borrowing costs that spurred equity extraction. It was also the rapid rate of house price appreciation -- an outgrowth of what Greenspan notes has been the 'unprecedented rate of existing home turnover' that he also attributes to sharply lower interest rates.

"Equity extraction has been the pixie dust of America’s post-bubble recovery -- the newfound purchasing power that has fostered the biggest consumption binge in post-World War II history. ..."

posted by Dave Iverson

Calculated Risk said...

Steve, the FDIC just released an interesting report on housing:

U.S. Home Prices: Does Bust Always Follow Boom?

There are some scary comments on the current situation (especially concerning sub-prime lenders and leverage).

Best Regards!

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