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.
In the US, for instance, I have said time and again that the price trend in the housing market is positive and this creates positive feedback with the economy. There is the real potential for the US to put the house price declines permanently in the rear view mirror. And this is especially true when you see that US real estate looks good relative to rent and on an income basis. The real threat in the US is political, and if that threat is realised as is my base case, I believe the resulting recession will cause US house prices to decline again.
Notice the markets that are most overvalued on a price-to-rent basis, which I see as most damning (in order): Canada, Hong Kong, Singapore, France, Australia, Sweden, Britain, Spain and the Netherlands. Finland is not in the list, but I imagine it would rank high in this category.
Here are the implications as I see them:
- Canada: I have written a decent amount on Australia and Canada as the two biggest housing bubbles that have yet to pop. I predicted that Australia’s bubble would pop in 2012 – and all appearances are that this has happened. For 2013, a good prediction to add to my list of surprises is that Canada’s housing bubble will pop. Transaction volume is already declining – and I believe this is a harbinger of problems for Canada’s housing market.
- France: I have written on France’s declining transaction volume as a negative credit accelerator. The French central bank has also admitted that France is now in a recession. Given the overvaluation of house prices, the drop in transaction volume, the fiscal tightening and the recessionary economy, this all speaks to negative feedback dynamics that will make France the country to watch in Europe for crisis stress. France is a country whose overvalued house prices are often overlooked.
- Australia: I expect the decline in house prices to continue in Australia and see the situation there as more advanced than it is in Canada. The Australian Labour government has continued to make noises about moving to a surplus position as a display of fiscal rectitude because of elections this year. They have already postponed this move due to the economy’s underperformance. I expect Australian fiscal targets to be missed in 2013, perhaps ending this promise of fiscal surplus. What impact this will have on the election is unknown.
- Sweden: I have less to say here but the Swedish market has been buoyant for a good while now and this is reflected in the overvaluation of house prices relative to rent. The economic situation doesn’t look bad, so I don’t expect big problems here in 2013.
- Britain: As with Spain, I see it as an amazing confirmation of how overvalued British house prices were during the housing bubble that they are still overvalued today after fantastic declines. Ireland and the US are undervalued. The worry in the UK is that austerity will add a contractionary impulse which feeds back negatively into housing. The house price declines in Britain are not necessarily over.
- Spain: The same goes for Spain here, with the contractionary fiscal impulse being more severe, making house price declines a certainty. Spain is a more dire version of the British scenario. And the negative impact this will have on bank balance sheets is one reason I believe the government will have to dig deep to recapitalise the Spanish banking sector.
- Netherlands: The major house price rise in the Netherlands was in the early 2000s. So it is remarkable how much the market is suffering now post-crisis. Willem Buiter expects more house price declines and writedowns in the Netherlands. This will create significant problems for private sector balance sheets as Dutch households are highly indebted. Likely, the Netherlands will continue to struggle on the fiscal side due to the negative impulse shrinking mortgage credit will add to the economy. And because the Dutch government is committed to austerity in the face of deficits, this will mean more austerity is coming in the Netherlands.
Germany looks good on housing, with prices still substantially undervalued compared to renting. The only other market of note that I haven’t mentioned here is Ireland. The market there is slightly undervalued. This puts the Irish in the best position of all of the peripheral countries. I think Ireland has a real shot at escaping the crisis and rejoining the core of the euro zone.
Source: The Economist