Britains Real Estate

The five ghastly "Jack the​ Ripper" murders took place in​ an​ area less than a​ quarter square mile in​ size. Houses in​ this haunting and​ decrepit no man's land straddling the​ City and​ metropolitan London could be had for​ 25-50,000 British pounds as​ late as​ a​ decade ago. How things change!

The general buoyancy in​ real estate prices in​ the​ capital coupled with the​ adjacent Spitalfields urban renewal project have lifted prices. a​ house not 50 yards from the​ scene of​ the​ Ripper's last - and​ most ghoulish - slaying now sells for​ over 1 million pounds. in​ central London, one bedroom apartments retail for​ an​ outlandish half a​ million.

According to​ research published in​ September 2002 by Halifax, the​ UK's largest mortgage lender, the​ number of​ 1 million pound homes sold has doubled in​ 1999-2002 to​ 2600. By 2002, it​ has increased elevenfold since 1995. According to​ the​ Economist's house price index, prices rose by a​ further 15.6% in​ 2003, 10.2% in​ 2004 and​ a​ whopping 147% in​ total since 1997. in​ Greater London, one in​ every 90 homes fetches even a​ higher price. the​ average UK house now costs 100,000 pounds. in​ the​ USA, the​ ratios of​ house prices to​ rents and​ to​ median income are at​ historic highs.

One is​ reminded of​ the​ Japanese boast, at​ the​ height of​ their realty bubble, that the​ grounds of​ the​ royal palace in​ Tokyo are worth more than the​ entire real estate of​ Manhattan. is​ Britain headed the​ same way?

A house - much like a​ Big Mac - is​ a​ basket of​ raw materials, goods, and​ services. But, unlike the​ Big Mac - and​ the​ purchasing power index it​ spawned - houses are also investment vehicles and​ stores of​ value. They yield often tax exempt capital gains, rental income, or​ benefits from occupying them (rent payments saved). Real estate is​ used to​ hedge against inflation, save for​ old age, and​ speculate. Prices of​ residential and​ commercial property reflect scarcity, investment fads, and​ changing moods.

Homeowners in​ both the​ UK and​ the​ USA - spurred on by aggressive marketing and​ the​ lowest interest rates in​ 30 years - have been refinancing old, more expensive, mortgages and​ heavily borrowing against their "equity" - i.e., against the​ meteoric rise in​ the​ market prices of​ their abodes.

According to​ the​ Milken Institute in​ Los Angeles, asset bubbles tend to​ both enhance and​ cannibalize each other. Profits from surging tradable securities are used to​ buy property and​ drive up its values. Borrowing against residential equity fuels overvaluations in​ fervid stock exchanges. When one bubble bursts - the​ other initially benefits from an​ influx of​ funds withdrawn in​ panic from the​ shriveling alternative.

Quantitatively, a​ considerably larger share of​ the​ nation's wealth is​ tied in​ real estate than in​ the​ capital markets. Yet, the​ infamous wealth effect - an​ alleged fluctuation in​ the​ will to​ consume as​ a​ result of​ changing fortunes in​ the​ stock exchange - is​ equally inconspicuous in​ the​ realty markets. it​ seems that consumption is​ correlated with lifelong projected earnings rather than with the​ state of​ one's savings and​ investments.

This is​ not the​ only counter-intuitive finding. Asset inflation - no matter how vertiginous - rarely spills into consumer prices. the​ recent bubbles in​ Japan and​ the​ USA, for​ instance, coincided with a​ protracted period of​ disinflation. the​ bursting of​ bubbles does have a​ deflationary effect, though.

In a​ late 2002 survey of​ global house price movements, "The Economist" concluded that real estate inflation is​ a​ global phenomenon. Though Britain far outpaces the​ United States and​ Italy (65% rise since 1997), it​ falls behind Ireland (179%) and​ South Africa (195%). it​ is​ in​ league with Australia (with 113%) and​ Spain (132%).

The paper notes wryly:

"Just as​ with equities in​ the​ late 1990s, property bulls are now coming up with bogus arguments for​ why rampant house-price inflation is​ sure to​ continue. Demographic change ... Physical restrictions and​ tough planning laws ... Similar arguments were heard in​ Japan in​ the​ late 1980s and​ Germany in​ the​ early 1990s - and​ yet in​ recent years house prices in​ these two countries have been falling. British house prices also tumbled in​ the​ late 1980s."

They are bound to​ do so again. in​ the​ long run, the​ rise in​ house prices cannot exceed the​ increase in​ disposable income. the​ effects of​ the​ bursting of​ a​ property bubble are invariably more pernicious and​ prolonged than the​ outcomes of​ a​ bear market in​ stocks. Real estate is​ much more leveraged. Debt levels can well exceed home equity ("negative equity") in​ a​ downturn. Nowadays, loans are not eroded by high inflation. Adjustable rate mortgages - one third of​ the​ annual total in​ the​ USA - will make sure that the​ burden of​ real indebtedness mushrooms as​ interest rates rise.

The Economist (April 2018):

"An IMF study on asset bubbles estimates that 40% of​ housing booms are followed by housing busts, which last for​ an​ average of​ four years and​ see an​ average decline of​ roughly 30% in​ home values. But given how many homebuyers in​ booming markets seem to​ be basing their purchasing decisions on expectations of​ outsized returns—a recent survey of​ buyers in​ Los Angeles indicated that they expected their homes to​ increase in​ value by a​ whopping 22% a​ year over the​ next decade—nasty downturns in​ at​ least some markets seem likely."

With both the​ equity and​ realty markets in​ gloom, people revert to​ cash and​ bonds and​ save more - leading to​ deflation or​ recession or​ both. Japan is​ a​ prime example of​ such a​ shift of​ investment preferences. When prices collapse sufficiently to​ become attractive, investors pile back into both the​ capital and​ real estate markets. This cycle is​ as​ old and​ as​ inevitable as​ human greed and​ fear.

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