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Observations On The Real Estate Cycle In The Us And China

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I've only skimmed over this paper from GMO but it looks like it might be of interest. Some charts we're familiar with...........

US - worst is over

China - worst is to come

The U.S. real estate cycle appears to be revolving somewhere between the stages of distress and quiescence. Some indicators are still decidedly negative. In particular, the high levels of foreclosures and distressed sales are a matter for concern. Unemployment also remains stubbornly high and over-indebted households are reluctant to borrow. However,

our checklist of housing trough indicators suggests that the worst is over: valuations are reasonable; mortgages are available; deflation has been dispersed; the construction overhang is largely gone; rents are rising; and a pent-up demographic demand is swelling. The long-term fundamentals for U.S. residential real estate are sound, however. When the economy eventually recovers and unemployment declines, household formation will rebound. Home prices will pick up together with construction. Another housing boom will follow


Edited by Red Knight

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I've only skimmed over this paper from GMO but it looks like it might be of interest. Some charts we're familiar with...........

US - worst is over

China - worst is to come

Not sure I agree that the worst is over for the US, that all depends on what happens when the sovereign defaults start happening, however China is going to have problems.


Cheng Siwei, head of Beijing's International Finance Forum and a former deputy speaker of the People's Congress, said interest rate rises and credit curbs to cool overheating were inflicting real pain on thousands of companies used by local party bosses to fund the construction boom.

"The tightening policy is creating a lot of difficulties for local governments trying to repay debt, and is causing defaults," he told a meeting at the World Economic Forum in Dalian. "Our version of subprime in the US is lending to local authorities and the government is taking this very seriously."

"Everybody assumes that they will be bailed out by the central government if they default, but I disagree with this. It means that the people will ultimately pay the bill for it all, at a cost to the broader welfare."

"Those who are not highly indebted are forced to help those who are," he said, echoing the debate over moral hazard that has divided opinion in the West since the banking rescues.

China clearly will end up popping, the question is when.

I wonder what will happen to local party officials when local govt default after helping to prop up Chinese GDP with deficit spending.

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IIRC the US started falling, generally, in Q4 2006.

5 years of falls. I have no idea if they are near the bottom but they cannot be far off. As for another boom ? 5 years of this will take a long time to get out of people's memories.

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I'll post this extract on 'The Trough' part of the cycle. Stuff to keep an eye on............

The Trough

Real estate markets spend longer going down or moving sideways than they do going up. Owing to the illiquid nature of real estate, property markets correct more slowly than stock markets. Hoyt describes the aftermath of the real estate boom as a “process of attrition.” Lenders are reluctant to push foreclosures. Homeowners, who have bought close to the top of the market, are reluctant to realize losses. Housing transactions dry up and home prices deflate

gradually. “The lack of short-selling,” writes Hoyt, “the tenacity with which owners cling to their mortgaged homes or apartments, and the slow and cumbersome process of foreclosures… prolongs the agony.”22

Severe downturns in the property market are often characterized by banking failures, surging vacancies, and a glut of supply on a lackluster market. “The wreckage is generally cleared away in four to five years,” writes Hoyt. In This Time Is Different, Professors Reinhart and Rogoff find that house price declines last on average for 6 years after a financial crisis.23 The downward phase of the cycle is prolonged by the deleveraging that follows great credit booms

(see Exhibit 5).

In general, the higher property prices go during the boom, the longer they take to decline. In the late 1980s, Japan experienced the greatest property bubble in history. After the market peaked in 1990, Japanese land prices fell for more than a decade. There is a rough symmetry between the degree of overvaluation at the top and the subsequent extent of the decline (see Exhibit 6).

At the bottom of the real estate cycle, the housing market is likely to exhibit the following characteristics:

• Low valuations. Property prices must be affordable before a sound recovery can take place. Normally this involves a fall in nominal home prices. Inflation can also play an important role as was the case after the UK housing bubble in the mid-1970s.

• Lower leverage. At the trough of the cycle, leverage is eschewed by both homebuyers and lenders. Loan-to-value ratios tend to be lower and deposits higher. More property transactions are all-cash deals.

Decline in foreclosures. Not only do foreclosures add housing supply at a time when demand is weak, they also signal to prospective homebuyers the risks of leveraged real estate purchases. “Foreclosures must run their course and old obligations be wiped out before the real estate market is in a position to revive,” writes Hoyt.24

• Credit availability. As long as unresolved bad property debts exist in the banking system, the real estate market remains vulnerable. Japan’s lengthy downturn in land prices only reached a trough after the banks were recapitalized following a second banking crisis in 2002.

• End to deflation. Deflation has a baleful effect on the housing market. While deflation raged in the early 1930s, the U.S. real estate cycle remained depressed. It is possible, however, for the real estate cycle to turn upwards even while deleveraging continues (i.e., when private credit is contracting relative to GDP). U.S. residential construction picked up after 1933 even though deleveraging lasted for the rest of the decade.

• Low housing turnover. As long as prices are falling, or appear vulnerable to further declines, potential buyers hold back, waiting to catch the trough. Homeowners with negative equity are trapped in their houses. Housing transactions decline to their low point at the trough.

• An economic recovery. New building permits and housing starts are traditionally considered leading economic indicators.25 The housing market is especially sensitive to changes in the level of employment. A sustained recovery depends on a widespread improvement in business conditions.

• Rising rents. Whilst people remain cautious of homeownership, the first effect of rising demographic demand is felt in the rental markets as rents start to rise. In time, rising rents push up the prices of existing homes and spur new construction.

Pent-up demographic demand. At the bottom of the cycle, new construction comes to a virtual standstill. The excess housing supply left over from the boom gradually diminishes and the property market finds support from new household formation. “An upturn in real estate activity,” writes Hoyt, “is usually started by a spurt in population growth, caused by… an increase in the rate of family formation.”26

• Continuing pessimism toward real estate. In the good times, a house is seen as a highly levered asset that only goes up. In the downturn, the same property is viewed as illiquid, expensive to maintain, and heavily taxed. Leverage is a snare. In the aftermath of Chicago’s first skyscraper boom, the Real Estate and Building Journal opined that “real estate is a liability rather than an asset.”27

In summary, the real estate cycle is ready to trough at the point when housing valuations are reasonable, underlying demographic demand is firm, boom era overbuilding has been absorbed, rents are rising, employment is picking up, and monetary conditions are accommodative. Several years must pass before the process of liquidation is complete.

Interesting comments on Reinhart/Rogoff's avg. 6 year declines following financial crises and also the role of inflation in the process noted for previous UK housing busts.

Sound familiar?

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  • 335 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?

      • down 5% +
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