Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

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Monday, June 20, 2005

More on the Housing Bubble

Reader MA is convinced we are experiencing a global housing bubble. To support his contention, he sent me two recent articles. The first deals with residential real estate in South Africa:

Paul Stewart, the chief operating officer of Plexus Asset Management, says there is strong evidence that a bubble exists in certain areas in the US. There has been too much investment in US real estate by builders and developers, and this has led to the supply of properties on the market outstripping the demand from buyers, Stewart says.

When there is an oversupply of rental property or, even worse, when owners cannot find tenants, fierce competition among owners for tenants results in rents falling and owners experiencing negative cash flows. Then, when interest rates rise - even moderately - over-indebted property owners get caught in a squeeze of falling yields and rising interest costs, Stewart says. These owners are usually forced to sell their properties quickly, and the large number of sellers leads to a fall in property prices.

...Stewart says that speculative growth in property prices has also been identified in other parts of the world, such as the United Kingdom, Canada, Australia and New Zealand.

...He says there is a common misconception that prices cannot fall in the property market, and that all that happens when a bubble bursts is that prices move sideways for a couple of years.However, Stewart says the examples of Japan and other Asian countries show that prices can fall - and these falls can be quite dramatic.

What concerns me about the U.S. housing market is the confluence of two related phenomena: the growth of reliance on interest-only mortgages, and the growth in second-home purchases. A rise in interest rates and/or an economic cooling-off could leave some mortgagors in pretty dire straits. The fact that housing prices have risen much less, on average, in Canada than in the U.S. could well be attributable to our relying far less on interest-only mortgages.

The other article MA sent quotes Deepak Parekh, Chairman, HDFC:
He said that today, warning signs are flashing in many global housing markets. Property market surveys have revealed that the ratio of housing prices to average disposable incomes is touching unsustainable levels.

In the US, house price inflation has been at double-digit rates since the past year. Another country feeling the pressure to curb speculation and keep the property market healthy is China.

"In India, residential property prices in some areas have recorded a growth of about 15 to 20 per cent in the last two years. This has raised concerns, and one of the questions being repeatedly highlighted is whether the escalation in demand and the resultant uptrend in prices have been driven purely by low interest rates and rising levels of affluence, or whether the success story has a speculative angle attached to it."
And, of course, some businesses are moving out of the higher-priced areas. The long-run price elasticity of demand for housing is greater than the short-run price elasticity.
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