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The Economist - Predictions For 2005

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I just flicked through The Economist's supplement of predictions for the world in 2005.

Unfortunately I don't think it's available electronically yet, but it basically predicts a painful, drawn-out bear market for house prices throughout the world over the next few years.

For the UK it is predicting real falls of 20-30% in that time.

Although many of us would prefer the 'pain' to be overwith more quickly than this, I think it's looking like good news for the bears.

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The econmist has been bearish about house prices for quite some time now. They have always likened house prices and rents to the Price/Earnings ratio for shares.

Thing is, from an economic point of view, house prices have looked overvalued for some time but until recently irrational investor behaviour has tended to ignore this.

Who reads the economist anyway?? ;)

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Home truths

Pam Woodall

From The World in 2005 print edition

new-house-prices.jpg

House prices have lost touch with reality. In 2005 they will come back down to earth

From London to Los Angeles and from Melbourne to Madrid, everybody is obsessed with the value of their home. The recent boom in house prices is one of the main reasons why many economies held up better than expected after the stockmarket bubble burst. Rising prices made home-owners feel wealthier and by taking out bigger mortgages they could spend their capital gains. Unfortunately, in 2005 the housing bubble will start to deflate.

Never before have house prices risen so fast in real (inflation-adjusted) terms in so many countries. Over the past year they have increased at double-digit rates in 11 of the 20 countries covered by The Economist’s global house-price indices. Since 1997 house prices have more than doubled in Australia, Britain and Spain, and almost tripled in Ireland. In comparison, the near-60% rise in average American home prices may seem modest, yet in real terms this is by far the biggest gain in recorded history and more than twice as big a rise as in the previous two house-price booms in the 1970s and 1980s. The big exceptions to the boom are Japan and Germany, where house prices have fallen.

The combination of record-low interest rates and a loss of faith in equities has encouraged more people to view homes not just as a place to live, but also as an easy way to make money—either through buy-to-let or by buying a bigger home than they need and then trading down when they retire. But buy-to-let has become less profitable, as rents in many countries now barely cover interest payments. No problem, say investors, we will make our profits from capital gains. That sounds ominously like an echo of the dotcom era, when analysts and investors argued that the link between share prices and profits no longer mattered. Home-owners are making a similar mistake today by ignoring the link between house prices and rents and buying on the expectation of capital gains. That is the very essence of a bubble.

Home prices now look significantly overvalued in America, Australia, Britain, France, Ireland, the Netherlands, New Zealand and Spain. In America the ratio of average house prices to rents or incomes is around 25% above its long-term average. In Britain, Australia and Spain homes are between 40% and 60% overvalued by this gauge. That makes them more overvalued than at previous peaks from which prices fell sharply in real terms. Add in China, Russia and South Africa, where markets also look dangerously frothy, and two-thirds (weighted by GDP) of the world tracked by The Economist’s indices have a potential housing bubble.

Many housing experts deny that home prices are overvalued, but their logic is flawed. Low interest rates, they argue, justify higher home prices. But interest rates are low largely because inflation is low. It is certainly true that initial interest payments are smaller, but because inflation is low it will not erode the real burden of debt so swiftly; in later years mortgage payments will absorb a much bigger slice of a borrowers’ income than when inflation was higher, so buying a home is not really cheaper over the whole life of a mortgage. Another popular claim is that home prices must continue to rise because there is a limited supply of land and the number of households is growing. The flaw in this argument is that if population growth is pushing up house prices, one would also expect rents to rise; instead they have been flat or falling in many countries.

A third argument of the optimists is that even if house prices are overvalued, prices will not fall but simply level off for a few years. House prices tend to be sticky downwards, because sellers prefer to stay put rather than accept a lower price. It is true that in most countries house prices have rarely fallen, but today two factors make a drop in prices more likely.

In the past, high general inflation helped to reduce real house prices back to fair value without the need for a fall in prices. But in a world of low inflation, house prices might need to stagnate for as long as a decade to allow incomes and rents to catch up. A second factor is that, unlike in previous booms, buy-to-let investors have played a big role in pushing up prices in many countries. If the market starts to wobble, investors are more likely to sell than owner-occupiers. That could put further downward pressure on prices.

The cracks have already started to appear: home prices have begun to fall in London and Sydney. In 2005 the rot in the housing market will spread wider. Prices will not suddenly crash like in the stockmarket; more likely they will slide gradually over several years, with a total drop of 10-20% in America, and 20-30% in Britain, Australia and Spain. Some markets will continue to inflate a bit longer than others, but eventually all housing booms end. This is the first global house-price bubble in history and its bursting could be painful.

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What is it with these 'drawn out slide' theories? Is anyone going to buy a house only to watch it slowly silde in value for a few years?

I think a few more months of stagnation/small falls at most, and the decline will be quite rapid, fuelled by a flurry of 'insultingly' low offers on houses that have been around for months setting much lower pricing levels.

At present the EA strategy seem to be 1. Put in the window at a shade below summer prices so casual observers don't notice the falls 2. When it sticks for week after week prime the seller for a -10 to -15% offer.

One they need to start putting those lower prices in the windows to interest more buyers, the whole country will be talking crash.

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Guest Charlie The Tramp
What an absolutely superb article.

BBB, TTRTR, your comments please.

Economist: The shocks of 2005 in the news blog free to view today sponsored by Phillips,even more interesting.

Interest rates have been rising, and they will go higher—perhaps much higher—in 2005. Emerging markets, especially those with piles of foreign debt, could feel the pain if American rates rise too far or too fast.

Well who says that IRs will go down?

Must be very brave people. :D

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What is it with these 'drawn out slide' theories? Is anyone going to buy a house only to watch it slowly silde in value for a few years?

I think a few more months of stagnation/small falls at most, and the decline will be quite rapid, fuelled by a flurry of 'insultingly' low offers on houses that have been around for months setting much lower pricing levels.

At present the EA strategy seem to be 1. Put in the window at a shade below summer prices so casual observers don't notice the falls 2. When it sticks for week after week prime the seller for a -10 to -15% offer.

One they need to start putting those lower prices in the windows to interest more buyers, the whole country will be talking crash.

The Economist has called the crash earlier, and been a bit premature. But as a general international view I think it's fair, if a bit broad. However I do , like you, wonder about the long slide theory. Unless the current movement of the market, which will certainly build up a head of steam by February is somehow slowed down, I can see a more dramatic 'correction' than a mere slide.

Without wanting to bore anyone, my firm which has 4 main offices in the SE and some associate firms are struggling in the residential sector, no doubt. For the first time in 4/5 years, we have no residential instructions relating to mortgages next week at all. Same story elsewhere. The recent bearish news which has been almost daily must surely tell even the hardest (thinking) bulls something. Or maybe not! Is this really the big one?

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The Economist has called the crash earlier, and been a bit premature. But as a general international view I think it's fair, if a bit broad. However I do , like you, wonder about the long slide theory. Unless the current movement of the market, which will certainly build up a head of steam by February is somehow slowed down, I can see a more dramatic 'correction' than a mere slide.

Without wanting to bore anyone, my firm which has 4 main offices in the SE and some associate firms are struggling in the residential sector, no doubt. For the first time in 4/5 years, we have no residential instructions relating to mortgages next week at all. Same story elsewhere. The recent bearish news which has been almost daily must surely tell even the hardest (thinking) bulls something. Or maybe not! Is this really the big one?

I think that low inflation will play a large part in precipitating a crash. The high inflation environment present in previous crashes made the falls relatively invisible. People do not factor inflation into their calculations when they think about the value of their house. How many times have you heard people say stuff like "well I bought in 1995 for 100,000 and sold in 2002 for 200,000 therefore I've made 100 grand"? People rarely say I've made an inflation adjusted profit of 60 grand.

First time buyers are going to be in a position where prices visibly fall as they view and consider making offers on places. I know this also happened before and is somewhat masked in the statistics by averaging across the whole country, but this time it will be everywhere. Psychologically this is a disaster it will kill sentiment stone cold dead.

It is different this time. Maybe before it was high interest rates and unemployment that stopped people from buying into an ostensibly flat market. This time it will be common sense stopping them from buying into an obviously falling market. Ten years of stagnation my ass, this markets going tits up as we speak.

Japhy

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