The Economist: Checking The Thermostat

[doogie]

Not a particularly bearish article until the last paragraph:

Checking the thermostat

Sep 7th 2006

From The Economist print edition

Property prices are cooling fast in America, but heating up elsewhere

HOUSES are not just places to live in; they are increasingly important to whole economies, which is why The Economist started publishing global house-price indicators in 2002. This has allowed us to track the biggest global property-price boom in history. The latest gloomy news from America may suggest that the world is on the brink of its biggest ever house-price bust. However, our latest quarterly update suggests that, outside America, prices are perking up.

America's housing market has certainly caught a chill. According to the Office of Federal Housing Enterprise Oversight (OFHEO), the average price of a house rose by only 1.2% in the second quarter, the smallest gain since 1999. The past year has seen the sharpest slowdown in the rate of growth since the series started in 1975. Even so, average prices are still up by 10.1% on a year ago. This is much stronger than the series published by the National Association of Realtors (NAR), which showed a rise of only 0.9% in the year to July.

The OFHEO index is thought to be more reliable because it tracks price changes in successive sales of the same houses, and so unlike the NAR series is not distorted by a shift in the mix of sales to cheaper homes. The snag is that the data take time to appear. Prices for this quarter, which will not be published until December, may well be much weaker. A record level of unsold homes is also likely to weigh prices down. The housing futures contract traded on the Chicago Mercantile Exchange is predicting a fall of 5% next year.

Elsewhere, our global house-price indicators signal a cheerier story. House-price inflation is faster than a year ago in roughly half of the 20 countries we track (see table). Apart from America, only Spain, Hong Kong and South Africa have seen big slowdowns. In ten of the countries, prices are rising at double-digit rates, compared with only seven countries last year.

European housing markets—notably Denmark, Belgium, Ireland, France and Sweden—now dominate the top of the league. Anecdotal evidence suggests that even the German market is starting to wake up after more than a decade of flat or falling prices, but this has yet to show up the index that we use, which is published with a long lag (there are no figures for 2006). If any readers know of a more timely index, please let us know.

Some economists have suggested that Britain and Australia are “the canaries in the coal mine”, giving early warning of the fate of America's housing market. The annual rate of increase in house prices in both countries slowed from around 20% in 2003 to close to zero last summer. However, the canaries have started to chirp again. In Australia average prices have picked up by 6.4% over the past year, although this is partly due to a 35% surge in Perth on the back of the commodities boom. Likewise British home prices have perked up this year, to be 6.6% higher, on average, than they were a year ago. Thus it is claimed that housing markets in Britain and Australia have had a soft landing.

Better still, their economies shrugged off the abrupt slowdown in prices last year. Consumer spending slowed sharply, but did not slump. If the British and Aussie canaries have survived, it is argued, then this bodes well for American homes—and for the American economy.

That might be the wrong lesson to draw. The housing boom has been responsible for a bigger chunk of growth in America than it was in Britain. America's saving rate has plunged, and consumer spending surged as homeowners borrowed with gusto against their capital gains. Britain's saving rate fell more modestly, so when prices flattened, the impact on consumer spending was smaller than it is likely to be in America. In Australia the slowdown in housing did make a big dent in construction and consumer spending but this was masked by the commodity boom and exports to China. The risk is that a flattening of house prices in America could prove much more painful it has been so far in Britain or Australia.

In any case, it is misleading to talk about a soft landing for house prices in Britain and Australia. The market has not really landed yet: prices are still sky-high relative to incomes and rents. The ratio of house prices to rents is a sort of price/earnings ratio for property. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income or as rent saved by an owner-occupier. Calculations by The Economist show that in Britain and Australia the ratios of prices to rents are respectively 55% and 70% above the long-term average (see chart). By the same gauge property is “overvalued” by 50% in America. Lower real interest rates than in the past would justify higher ratios, but nowhere near all of the rise in house prices.

An OECD study published last year adjusted the price/rent ratio for interest rates and other factors, to estimate how overvalued home prices were around the globe. Updating those figures to take account of price rises since then suggests that housing is now 35-50% overvalued in Britain and Australia and perhaps 20% too dear in America. A return to fair value will mean either rising rents or falling prices. If rents continue to rise at today's pace, many years of stagnant prices will be required to bring the price/rent ratio back to its long-term average. Especially after a giddy ascent, it is too soon to talk about a soft landing before a return to firm ground.

Edited September 8, 2006 by doogie

[Realistbear]

Calculations by The Economist show that in Britain and Australia the ratios of prices to rents are respectively 55% and 70% above the long-term average (see chart). By the same gauge property is “overvalued” by 50% in America. Lower real interest rates than in the past would justify higher ratios, but nowhere near all of the rise in house prices

.

Sounds about right. House prices are considerably lower in the US despite the bubble when you measure them against disposable incomes. Their bubble markets oin the coasts are up about 120% over 6 years we are up 300% since the Miracle Chancellor took over. Our private debt is 1.24 Trillion pounds which is considerably higher than the US equivalent of 11.1 trillion $ at current exchange rates (US population is roughly 5 times that of the UK).

Great Crash 2 should exceed Great Crash 1 by a considerable margin IMO for the reasons cited by the Economist.

Edited September 8, 2006 by Realistbear

[Cuckoo]

Calculations by The Economist show that in Britain and Australia the ratios of prices to rents are respectively 55% and 70% above the long-

Great Crash 2 should exceed Great Crash 1 by a considerable margin IMO for the reasons cited by the Economist.

Anecodotally though, rents are rising pretty fast here in the UK and don't look that cheap. Even though there's a "lot" of btl's, rents haven't softened at all.

[OzzMosiz]

Anecodotally though, rents are rising pretty fast here in the UK and don't look that cheap. Even though there's a "lot" of btl's, rents haven't softened at all.

Excellent. Higher rents = higher inflation = higher interest rates

[Fancypants]

Anecodotally though, rents are rising pretty fast here in the UK and don't look that cheap. Even though there's a "lot" of btl's, rents haven't softened at all.

anecdotally, that's completely inaccurate out here in the real world. There is some upward pressure on rents, as landlords who have bought recently begin to feel the pinch, but most tenants quickly realise that there are cheaper alternatives available.

[Realistbear]

Anecodotally though, rents are rising pretty fast here in the UK and don't look that cheap. Even though there's a "lot" of btl's, rents haven't softened at all.

Sadly for the market it isn't happening everywhere. My rent has been the same for over a year whereas my landlord's overheads have increased which means REAL rents are still falling. With the new regime kicking in with local authorities able to start taxing HMOs and including smaller BTLs in the net at their discretion the market will trun even more sharply downward yeild-wise. The time to have bailed out of BTL was probably very early 2005.

IMO rising levels of unemployment bode ill for the future rental markets as the masses of unemployed will not have the income to pay their existing rents let alone any hoped for increases.

[dnd]

Excellent. Higher rents = higher inflation = higher interest rates

Alternatively. Higher rents = higher inflation = interest rates on hold + increased immigration + redefining/hiding inflation (CPI)

They won't raise IR to the point of crashing the housing market....

[PropertyGuru]

real rents have been falling for years - that's one of the reaosns I got out.

Tenants are savvy nowadays - they know they can call your bluff. It became really annoying.

[OzzMosiz]

Alternatively. Higher rents = higher inflation = interest rates on hold + increased immigration + redefining/hiding inflation (CPI)

They won't raise IR to the point of crashing the housing market....

It's different this time

[dnd]

It's different this time

Why? - is it a 'feeling' you have?

Edited September 8, 2006 by dnd

[Zzzzzzzzzzzzzzzzzzzzzzzzzz]

Anecodotally though, rents are rising pretty fast here in the UK and don't look that cheap. Even though there's a "lot" of btl's, rents haven't softened at all.

How high can the rents go before people are (1) Forced to emigrate (2) Forced onto benefits or into pushing for much higher salaries? People were pushed before. If rents are now increasing, as you write, the economic blowback will surely be dire, ultimately impacting on house prices.

[iamnumerate]

Anecodotally though, rents are rising pretty fast here in the UK and don't look that cheap. Even though there's a "lot" of btl's, rents haven't softened at all.

Are you sure ? I think rents have softened certainly I don't find getting lodgers that easy.

[neitherbullnorbear]

Interesting article by the Economist, although, as the predictions page of HPC reminds us, in 2002 they were predicting a crash in, er 2004. Not a very good summation in terms of the calculations though. Undoutedly a lowish IR environemnt (even if they head up, peak likely to be lower than in past), prolonged economic stability, planning constraints, immigration, attraction of property as a long term invesmtnent, two income households, more households, shift away from social housing etc, etc have had some effect - the debate is really how much.

Equally, it is clear that property is almost certainly over priced - but the Economist offers a very simplistic calculation when it comes to how much. The price:income ration is a far weaker tool than it is portrayed. I doubt there is such athing as "fair value" in teh property market, but, if pushed, I woul dsay property is 10-15% overpriced.

Fiannly, I notice the Economist seems a bit shy on making predictions, unlike the ealrier this decade. perhaps they have learnt their lesson.

[Scooter]

Interesting article by the Economist, although, as the predictions page of HPC reminds us, in 2002 they were predicting a crash in, er 2004. Not a very good summation in terms of the calculations though. Undoutedly a lowish IR environemnt (even if they head up, peak likely to be lower than in past), prolonged economic stability, planning constraints, immigration, attraction of property as a long term invesmtnent, two income households, more households, shift away from social housing etc, etc have had some effect - the debate is really how much.

Equally, it is clear that property is almost certainly over priced - but the Economist offers a very simplistic calculation when it comes to how much. The price:income ration is a far weaker tool than it is portrayed. I doubt there is such athing as "fair value" in teh property market, but, if pushed, I woul dsay property is 10-15% overpriced.

Fiannly, I notice the Economist seems a bit shy on making predictions, unlike the ealrier this decade. perhaps they have learnt their lesson.

Timing is so hard and they got it wrong plenty of times so far. I get ridicule from friends who I tried to convince of an imminent HPC 2 or 3 years ago.

Edited September 8, 2006 by Scooter

[Waitingforthesun]

Timing is so hard and they got it wrong plenty of times so far. I get ridicule from friends who I tried to convince of an imminent HPC 2 or 3 years ago.

I agree. Timing correctly the markets is very difficult, the only ones who succeed are generally lucky.

Shiller become famous because he published "Irrational exhuberance", his bearish book on tech stocks just before the tech bubble popped and Nasdaq crashed. But in fact, we was a bear on US stock markets since 1996 ... and even in 2003, the Dow was still higher than 1996. Of course, for him, it was still fine cause he entered the stock markets in 1982, at the early begining of the big bull stock market - but he missed a lot of profits by calling the peak too early

In 2002, he sold his US real-estate investment, calling (again) the peak too early, like The Economist, which is annoucing a worldwide HPC every year since 2002, and has been proved wrong so far.

I do not dare to make any predictions to my friends, since the market has climed so high and so fast, and since UK has experienced a "soft-landing" and a "bounce-back". I am afraid Benmarke will cut his rate very quickly when US market will go south, and the Chinese/Japanase will continue to support the dollar (they don't care about inflation, they need customers for their exports). I just answered to my friends : "I don't know what the future will be about, I just know that last time real estate crashed, but maybe it'll be different this time, who knows, I'll see"

[neitherbullnorbear]

Timing is hard - though let us not forget that this is a board dedicated to trying to time the market.

[Larry Livingstone]

http://www.comstockfunds.com/index.cfm?act...;menugroup=Home

re. US stock market bear commentary

A Precarious Balance

What investors want most is exactly what the consensus of economists and strategists are forecasting—a soft landing with minimal inflation, no further Fed tightening and interest rate cuts some six months down the road. This outcome is, of course, most often referred to as the Goldilocks economy—not too hot and not too cold. Unfortunately, this is arguably the least likely outcome. The economy is balanced precariously between a soft landing and recession; between inflation, deflation and stagflation; and between the possibility of Fed rate hikes or cuts.

So delicate is the balance between these factors that any daily new economic statistic or utterance by someone in authority shifts the market first one way, then another. The odds of landing directly in the most favorable position seem very low, and, indeed a review of financial history indicates that soft landings are extremely rare. In the last 50 years, only nine times have we simultaneously experienced a combination of tight money, an inverted yield curve and a decline in the Conference Board index of leading indicators over a six-month period. In eight of those nine times the economy suffered a recession, while the market entered a bear cycle in every instance.

Even those who believe that a soft landing is the most likely result this time around can point to only two previous such outcomes in the post-war period—1984-85 and 1994-1995. We point out, however, that in both of those instances the yield curve did not invert, and in addition the leading indicators did not decline over a six-month period in 1984-1985. In fact, during the latter period it is not even clear that the Fed tightened since the discount rate that the Fed was still targeting at that time was raised only once. In addition the hard landing of the housing sector that is becoming more obvious every day vastly decreases the chances that the economy can escape unscathed.

Remember, too, that the only thing not too hot or cold in the Goldilocks saga was the porridge. As we recall, poor goldilocks herself had to flee when the three bears came home. Although anything can happen in the economy or market, it seems to us that the chance of a soft landing is quite small and that the odds of recession and a bear market are exceedingly high.

Edited September 8, 2006 by Larry Livingstone

[the_duke_of_hazzard]

Anecodotally though, rents are rising pretty fast here in the UK and don't look that cheap. Even though there's a "lot" of btl's, rents haven't softened at all.

I've rented 6 places in London in the last 8 years. Prices of rents have been static or, if anything, falling. Rents seemed expensive compared to buying when I started. Now they seem cheap.

[RichM]

I've rented 6 places in London in the last 8 years. Prices of rents have been static or, if anything, falling. Rents seemed expensive compared to buying when I started. Now they seem cheap.

Ditto. Renting is dead easy. We have been offered somewhere at about 300-400 quid per month under the market rate (Clapham way), but will go for a house share with people we know where it will be even cheaper for us.

Yes you can buy right now as a FTB if you try really hard, but you can also rent for much less than the high street EAs tell you if you try moderately hard.

[Ologhai Jones]

Equally, it is clear that property is almost certainly over priced - but the Economist offers a very simplistic calculation when it comes to how much. The price:income ration is a far weaker tool than it is portrayed. I doubt there is such athing as "fair value" in teh property market, but, if pushed, I woul dsay property is 10-15% overpriced.

Given that 'traditionally' [1] mortgage lenders have used mortgage multipliers of, say, 2.5 or 3, and that a FTB's salary might be, say, 15 to 20k, and that a FTB may be able to come with a 10% deposit, then a typical FTB's house should cost no more than, say, 60k or so.

Here in Deepest Staffordshire, the cheapest houses in my town are around £85k... and, not being an EA, 'opportunity' isn't a word I'd use to describe them.

If this calculation has any meaning at all, then house prices could be said to be at least 40% higher than perhaps they 'should' be.

[1] In all honesty, I don't know how typical multipliers have changed over the years, but it would make an interesting graph in itself.

[Fancypants]

Ditto. Renting is dead easy. We have been offered somewhere at about 300-400 quid per month under the market rate (Clapham way), but will go for a house share with people we know where it will be even cheaper for us.

Yes you can buy right now as a FTB if you try really hard, but you can also rent for much less than the high street EAs tell you if you try moderately hard.

thirded. That is exactly what we are doing, and while not perfect, it allows us a good lifestyle while also being able to tuck money away for when the moment arrives.

[JustYield]

Interesting article by the Economist, although, as the predictions page of HPC reminds us, in 2002 they were predicting a crash in, er 2004. Not a very good summation in terms of the calculations though. Undoutedly a lowish IR environemnt (even if they head up, peak likely to be lower than in past), prolonged economic stability, planning constraints, immigration, attraction of property as a long term invesmtnent, two income households, more households, shift away from social housing etc, etc have had some effect - the debate is really how much.

Equally, it is clear that property is almost certainly over priced - but the Economist offers a very simplistic calculation when it comes to how much. The price:income ration is a far weaker tool than it is portrayed. I doubt there is such athing as "fair value" in teh property market, but, if pushed, I woul dsay property is 10-15% overpriced.

Fiannly, I notice the Economist seems a bit shy on making predictions, unlike the ealrier this decade. perhaps they have learnt their lesson.

NBNB

I'm intrigued to know what valuation metric you use for property and what aspect of the following you think is weak:

The ratio of house prices to rents is a sort of price/earnings ratio for property. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income or as rent saved by an owner-occupier.

In what way is this analysis 'very simplistic' and what presumably 'complicated' measure would be better, in your opinion?

JY

[JustYield]

NBNB

I'm intrigued to know what valuation metric you use for property and what aspect of the following you think is weak:

In what way is this analysis 'very simplistic' and what presumably 'complicated' measure would be better, in your opinion?

JY

bump.

[dredwerker]

Given that 'traditionally' [1] mortgage lenders have used mortgage multipliers of, say, 2.5 or 3, and that a FTB's salary might be, say, 15 to 20k, and that a FTB may be able to come with a 10% deposit, then a typical FTB's house should cost no more than, say, 60k or so.

Here in Deepest Staffordshire, the cheapest houses in my town are around £85k... and, not being an EA, 'opportunity' isn't a word I'd use to describe them.

Blimey 85k way down in Hove next door they pay £600 per month for a one bed flat. I think the BTL Landlord paid circa £130k for it. Cant seem to find it using ourproperty.co.uk there must be quite a lag. Seems like 1990's Brighton Prices.

Makes you think about living in the south

[88Crash]

I've rented 6 places in London in the last 8 years. Prices of rents have been static or, if anything, falling. Rents seemed expensive compared to buying when I started. Now they seem cheap.

I'd agree with that

I've also been renting for the last 8 years in Surrey

First place was £1,000 per month for a 150K house = rent was approx the same as buying

Current place £1,825 per month for a 700K house = rent far cheaper than buying (plus NO DIY!)