In the past year, I have increasingly turned away from the US housing market to stress the difficulties now besetting other global housing markets. The US market is one of the four housing markets in the world’s largest economies to have crashed in the 2000s, along with the Irish, Spanish and British housing markets. The problems there are known. But there have been large house price appreciations (and some declines) elsewhere in places like the Netherlands, Denmark, Australia, Canada, France, Finland and Sweden.
The Economist has a good round-up of global housing market prices that looks at the over- and undervaluation in the most important housing markets in the world. Below is a chart of this accompanied by the following analysis:
To gauge whether homes are cheap or expensive we use two measures, both of which compare current estimates with a long-run average (in most countries, going back to 1975). This average is our benchmark for “fair value”.
The first gauge is a price-to-rents ratio. This is analogous to the price-earnings ratio used for equities, with the rents going to property investors (or saved by homeowners) equivalent to corporate profits. The measure displays a massive range, from a whopping 78% overvaluation in Canada to an undervaluation of 37% in Japan. The other measure, the ratio of prices to disposable income per person, stretches from a 35% overvaluation in France to a 36% undervaluation, again in Japan.
America’s housing-market revival looks sustainable in part because the sharp correction in house prices over the past few years has made homes cheap by historical standards. A year ago house prices were still falling, by 3.6%. There has been a turnaround since: the latest data show prices rising by 4.3%. But based on the ratio of prices to rents, houses are still 7% undervalued; judged by the price-to-income ratio, they are 20% below fair value. It also helps that mortgage rates are at historic lows and are likely to stay that way, since the Federal Reserve has promised to keep an extremely loose monetary stance for the next couple of years.
I think these two gauges are good first cuts because the price-earnings ratio gets to how expensive house prices are in relative terms as compared to other asset classes while the price-to-rents ratio gives you a sense of the relative price of housing’s alternative use as a rental instead of a sale. In both cases, what you want to see is the ratio trend and absolute level to get a sense of the dynamics of the situation and its potential impact on credit as a vehicle toward adding to or subtracting from GDP growth.
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