It’s a chain reaction that was bound to strike sooner or later – housing bubbles here, there, and everywhere. The global housing market looks just like a birthday party with dozens of overexcited kids filling the air with soap bubbles.
Canada, Belgium, New Zealand, Norway, and Australia all have home prices more than 40% above their historical averages relative to family income. France, U.K., Sweden, and Finland are all more than 20% above their historical averages, while Spain, the Netherlands, Austria, and Denmark are all more than 10% above their averages, according to data recently published by Deutsche Bank economists Peter Hooper, Torsten Slok, and Matthew Luzzetti.
Asia is another link in this chain reaction, with property prices in 2013 soaring 28.5% in Dubai, 21.6% in China, 16.1% in Hong Kong, 15.4% in Taiwan, and 13.5% in Indonesia.
Even in one of the hardest hit nations, America, property prices are up 11% over a year ago and 14% above their recent lows at the end of 2011, with the overall price increases creating an additional $2.8 trillion of home owner wealth since then.
What many are asking now is, “When will it all end?” Booms do not take long to collapse into busts. And it may happen with a few simple upcoming changes to government monetary policy. Why? Because that’s what started this chain reaction in the first place.
What Blew the Bubbles
It all began with the financial crisis in 2008, which spread around the globe by the following year. With hundreds of billions of dollars worth of investments from America to Europe to Asia becoming near worthless in a matter of months, liquidity evaporated and credit froze up. In an effort to pump liquidity back into their economies, one government after another began slashing interest rates to make money cheaper for businesses to borrow.
This also made it easier for home buyers to borrow, as lower central bank rates triggered lower bond rates, which triggered lower mortgage rates. After some four years of literally tossing cheap money at their citizens, nations all over the world are now reaping the reward (others would say curse) of re-inflated housing prices (others would say over-inflated).
Yet recently the U.S. Federal Reserve has been talking about reducing its monthly purchasing program, which includes cutting back on $40 billion spent buying mortgage-backed securities each month. Mortgage rates in America have already surged over 1% since taper talk first began in May. The housing market is already beginning to feel the pinch, with a slowdown expected as early as next year.
Slower Growth, But Stable
Macroeconomic research firm Capital Economics thus expects U.S. housing prices to grow by only 4% in 2014 and slow “sharply” over the next several years as the Fed raises interest rates back to normal levels, taking many buyers out of the market.
In addition to gradually rising interest rates, home price increases are expected to slow on account of more balanced supply/demand fundamentals. The glut of homes foreclosed upon has dried up and the cheap bargains are gone, leaving only the moderately valued to overvalued properties for buyers to choose from. As a more balanced supply of homes and higher mortgage rates thin out the crowd of buyers, sellers are expected to begin lowering their asking prices.
Yet Capital Economics sees a number of other factors surfacing in 2014 to provide some upward lift to home prices and keep them well supported. Fewer buyers are expected to force banks and mortgage providers to keep their mortgage rates at bay and even loosen their approval criteria somewhat to replenish the sales volume lost on account of dissipating refinancing activity.
The firm also anticipates the passage of the recent budget deal to have a positive effect on housing, as the reduction of sequestered cuts will further stimulate an already impressive job creation trend, which will enable new home buyers to enter the market.
Capital Economics notes that despite the recent rise in mortgage rates this year, they are still at nearly half of their historical average of 8.59%. Until rates climb back up to that average, the firm sees housing purchases as still expanding, not shrinking.
“Experience prior to the credit crunch suggests that 30-year rates need to reach 8 percent to 10 percent to reduce home sales below their current level,” Capital Economics’ Paul Diggle wrote in a note obtained by the International Business Times. “In other words, a rise in mortgage rates to 5 percent or so is unlikely to do lasting damage to housing market activity. Even if mortgage interest rates edge a little higher, the recovery in housing market activity should continue.”
The firm sees that activity remaining strongest in North Dakota, South Dakota, and Oklahoma and weakest in North Carolina and Delaware.
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Investing on Averages
While so many housing markets around the world are clearly overheating due to interest rates being kept low for so long, the U.S. housing market by comparison is not quite overheating just yet. Likely because it was one of the deepest hit, America’s ratio of average home prices to family income as noted by Deutsche Bank’s economists is actually below its historical average – some 6% below.
Capital Economics’ Diggle corroborates with estimates of his own, putting America’s average housing values at some 12% below their fair value. Though this is not as great a bargain as it was back in 2011 when prices averaged some 21% below market value, the U.S. housing market has been managing to run cool.
If you have been thinking about jumping into real estate but have been repelled by mortgage rates at current levels, simply note the long term average and consider this one of your best opportunities in a long, long time. The National Association of Realtors’ affordability index concurs, showing the U.S. 30-year mortgage rate since 2009 to be the most affordable it has been in 40 years.
Just be certain to compare the various regions, since not all present similar bargains. While home prices in most metropolitan areas in the U.S. are still at levels considered greatly undervalued, about ten centers are considered to have returned back to normal price ranges: Austin, Bethesda-Rockville-Frederick, Dallas, Denver, Houston, Nashville, Orange County, San Francisco, San Jose, and Seattle. Yet even these represent fair value at near normal prices.
Don’t fear Fed tapering coming to a bank near you; interest rates will still be ultra low for a couple of years more before the Fed starts raising them. And with a thinning heard of buyers, you should see home prices come down some too. While bubbles are blowing in a multitude of other countries, there isn’t really one here. And you can’t burst something that isn’t blown out of proportion.
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