The housing market is like other financial markets: price expectations create momentum that drives prices arising from normal affordability ratios. But they must eventually return to these norms through “mean reversion”, creating the endemic booms and busts of cycles.
The restaurants tell the story. Walk around the affluent neighbourhoods of London, New York, Hong Kong or any of the prime residential markets of France and take a look at the restaurants. The best are nearly always full; the rest not always so.
Those in the fine dining joints of Manhattan, Chelsea and Central Hong Kong are feeling richer than they were two years ago, when the economic downturn hit all their investments, not least their homes. The subsequent bounce in financial markets has left them feeling better off. Not surprisingly, given the connection between financial markets and luxury homes, the values for properties above £1m have also improved.
The same story is told by the developers and owners of the prime residences across the world: the market is back, in some places pushing prices back to and even beyond their peak of 2007. And yet undercutting the words of even the most bullish of market participants seems to be a slight sense of unease. The market might be good again today – having seen prices bounce off the floor found at the end of 2008 – but tomorrow is not so certain.
In fact, in spite of a modest growth over the past year in almost all global housing markets, there are now worries that these markets could follow economies into the dreaded “double dip”. After the shock of the financial crisis, most housing markets have at least stabilised, while some have bounced back strongly. But concerns that the situation remains fragile are growing. In the UK, the Royal Institution of Chartered Surveyors has reported that members are seeing more falls than rises, that a fall in buyers’ enquiries is dragging prices lower, and predicts a fall of 5 per cent in 2010, and continuing declines in 2011. In the US, Alan Greenspan has expressed concern that the “small dip” in house prices, which he says most economists predict, would induce a major increase in foreclosures, which could feed on itself.
There are two broad schools of thought about the determinants of house prices. Jean-Michel Six, chief economist in Europe at Standard and Poor’s, the rating agency, adopts a financial market perspective. In his view, we might not yet have witnessed a full correction of some of the imbalance that the 1997-2007 housing bubble created, such as decreasing affordability or surging price-to-rent ratios. The housing market is like other financial markets: price expectations create momentum that drives prices arising from normal affordability ratios. But they must eventually return to these norms through “mean reversion”, creating the endemic booms and busts of cycles.
By contrast, Lucian Cook, director at Savills, the international estate agency, looks more to fundamentals of supply and demand for property itself. But he is also gloomy. He emphasises sluggish demand and he argues that “the slide looks more correlated with the economy, with sentiment turning just as things here look worse for people’s wallets”. He adds: “Price movements can lie but transaction numbers never do, and they are now much lower than last year’s even though mortgage availability has improved.”
Both the momentum school and the supply and demand school are right, of course. Movements of house prices are always the product of a mix of price expectations and underlying fundamentals. The housing market is influenced by two powerful, but distinct, forces: the desire for a safe and profitable investment and the need for a place to live. And these motives play different roles in different places at different times. There is no global housing market. Some factors are universal: the credit crunch hit consumer confidence and affected the availability of finance for house purchase everywhere. But the stimulus packages adopted around the world, and the measures adopted to keep people in their homes, have generally stabilised conditions. Several countries have targeted stimulus measures directly on home buyers, such as the US with its federal tax credit. But, looking forward, the experiences of different national housing markets in the next 10 years are likely to be as different as they were in the 10 that preceded the credit crunch.
Some countries – Spain, Ireland, Dubai – saw a housing bubble. In these countries a large part of market activity was accounted for by buyers who saw houses as attractive speculations rather than places to live. They expect to sell on the houses in a short time to someone else, or to realise cash by refinancing purchases on the back of ever rising house prices. With house builders anxious to get in on the act themselves a construction boom followed. In these markets, the bursting of the bubble has left a continuing oversupply of property and there can be no sustained revival until that backlog has been worked off. Every appearance of recovery will result in speculators and financiers unloading their holdings.
In some other countries that experienced large house price rises, such as the UK and France, both speculations and fundamentals played a part, but there was a better balance between the two. Most people who bought houses bought them in order to live in them, not to sell them. Rising prices were an intelligible response to much lower levels of both nominal and real – inflation-adjusted – interest rates. In these countries, prices also benefited from shortages of desirable property and land to build it on in many areas. Prices might have overshot a bit, as they do in all asset markets, but overshooting a new equilibrium is not the same as a bubble in which prices cease to bear any relation to fundamentals.
If metrics based on the ratio of house prices to earnings look historically high – and mostly they do – metrics based on average monthly outgoings, which are what determine affordability for most households, are still relatively favourable. In the UK, mortgage payments as a percentage of take-home pay have fallen below the historic average – a boon to those who can access the lower interest rates, though that tends to be those already on the housing ladder or able to muster large deposits.
Jon Hunt, the founder of Foxtons, who was seen to have called the top of the market accurately in 2007 with the sale of his London estate agency for more than £350m, says that this downturn was nothing like the crash of the early 1990s, when rocketing interest rates spelled agony for many homeowners. Having turned an investor in property, Hunt concludes: “The really hard collapse is over even if the market might not go anywhere for a while. We have been buying and continue buying where we see value. London is a really interesting residential place at the moment. There is a massively reduced supply.”
Supply and demand for property as a place to live is all-important in markets such as Germany and Switzerland, where the investment motive has never been an important factor for private individuals. When there is no recent experience of rapid inflation or where land is plentiful a house is a residence, not a financial instrument. Younger people tend to rent property and owner-occupation represents a much lower population of the housing stock. Markets are likely to be as boring in the future as in the past.
The largest housing market of all – the US – is no more a single market than is the European market. Different areas of that country have seen very different mixes of speculative motive and economic fundamentals in the behaviour of their housing markets. In some areas of the country – such as Florida – off-plan purchasers who believed that prices were sure to rise bought in the expectation of flipping their properties at a profit. In others – such as the inner cities, where the subprime scandals were most extreme – unaffordable purchases or equity withdrawals were supported by the expectation that refinancing would always be possible, but this was never a universal picture. In smaller towns in red states, where there is no shortage of land to build and no large premiums for location, prices have never moved far from what it costs to build.
The market for prime property in the top cities is the only truly global market. Demand for these properties is closely tied to the fortunes of the financial sector and in the months immediately following the collapse of Lehman, luxury apartments in London and Hong Kong saw the biggest quarterly falls they have experienced.
The luxury market in Manhattan has been slowest to recover; partly because overseas demand has reduced because of the strength of the dollar against the euro. Real estate in cities such as London and in the prime markets of the South of France remains in demand from overseas buyers, who typically account for half of properties above £15m.
For the foreseeable future, there will be economic headwinds to much further house price growth, outside exceptional markets such as China and the associated commodity-rich countries of Asia, Africa and South America. Mostly, however, historically low interest rates and the basic undersupply of good quality homes in places where people want to live and raise families underpin the current general level of house prices. These might slip again in some countries but so long as the global economy heads in the right direction the prospects of a widespread house price crash from these levels look remote.
This article was written together with Daniel Thomas, the FT’s property correspondent.