Friday, Feb 20, 2009
Excellent mathematical summary
Telegraph: Letter
A thought on house prices from Germany, where I live. Here, house prices have risen by 25% since 1990. The market is healthy.
A friend of mine in London is trying to sell a house for 580,000. He bought it in 1976 for 15,000.
Now, let's allow a factor of 12 for general inflation, makes 180,000.
Let's allow a REAL average return of 2% -- not bad for a risk-free investment, and let's take the base to be the higher of the above figures. 180,000 accruing compound interest of 2% over 33 years is 345,600.
That's what I think his house is worth. What other investment of 15,000 in 1976 would have produced such a return? But would he accept such an offer? In fact, would anyone be cheeky enough to make such an offer? No, and no. No wonder the market has collapsed.
9 Comments
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1. bellwether said...
Don't see why any return should be assumed for non investement except as a function of GDP growth ie there is no other reason for it to grow in value.
GDP growth and inflation have been virtually indistinquisable for much of the past 2 decades so property should only have increased moore or less in line with inflation. Every increse beyond that is bubble.
2. jackas said...
Any offer I have ever made for a house (all of which has been laughed off) have been calculated on exactly that basis. 2% real return plus the what the governemnt says about inflation. When one of those gets accepted, I'll be a homeowner. Which will be weird.
3. tudorian said...
@ Bellwether
Agreed sir.
Rampant house price inflation resulting in boom / bust and negative equity are now as much a part of our psyche as fish'n'chip. I can only look upon the German, knowing that it will never be like that in UK
4. bob1 said...
bellwether
"GDP growth and inflation have been virtually indistinguishable for much of the past 2 decades so property should only have increased more or less in line with inflation".
I suppose you'd have to factor in a small population increase because housing supply was always slightly behind the demand curve. Maybe also factor in a small increase because of the house extension and improvement craze. It’s unlikely that this house hasn't benefited from an upgrade since 1976
5. mountain goat said...
Jackas - your method sounds sensible but may not pick the bottom because bubbles tend to overshoot the mean. My personal entry point is this quote from an investment group last year:
"Banks typically start to outperform a year before the trough in property prices, which we believe is roughly two years away."
In other words if there is convincing recovery in bank shares, then a year later housing starts to turn up. Makes sense because by then banks will have recapitalised and feeling confident in lending mortgages again.
6. mark wadsworth said...
The maths is crap.
"let's allow a factor of 12 for inflation"
Nope. It's more like 5, using RPI or the GDP deflator here.
Even using 'share of GDP' (i.e. GDP growth plus inflation growth), the house would 'only' have gone up to £156,000.
7. Al said...
@ Mark (6) - it may be a lower inflation figure, but the maths errs on the 'worst case' scenario to underline just how much house prices have overshot. Thanks for the comment, though, as it supports the frustration felt by many.
8. another alan said...
mg's comment is worth paying attention to.
9. 51ck-6-51x said...
I agree with bellwether & mountain goat, however the 15,000 was not necessarily the real value to start with either, so on a single instance of a heterogeneous asset it's an almost pointless exercise.