Global Property Bubble Starting to Deflate
Right around the world some of the premier cities for real estate investment are flashing red warning signals that the global property price run up facilitated by central banks dropping interest rates through the floor and printing trillions in extra currency units is approaching its end.
In cities like Melbourne, Sydney, London, Toronto, Beijing and New York sales are falling and prices have started to slip. Given central banks goal of driving economic growth through asset price bubbles, a policy which they doubled down on in the period since 2008 any stall out in either property or equities is a cause for alarm.
In Australia, because of the decades long boom in real estate prices, any prediction of an end to the ever rising trend in house prices has typically been laughed off. Australia suffered much less from the 2008 crisis than countries like the UK, USA and Ireland and consequently did not get a much needed house price correction back then either. As a result Australia today is massively exposed to a house price correction on an even larger scale than the current bubbles in US and western european property markets. Australia has now had 11 consecutive months of house price declines and if weakening Chinese activity in Australian real estate is any guide this process is only beginning.
In the USA the Federal Reserve has made the market believe that is in complete control of all events and this has driven stock markets to absurd levels. Look at the crazy valuations on loss making companies like Tesla (loses money on every car it sells) and Netflix (loses more money the more content it produces). So fear has gone and greed dominates. This has spread into the real estate and in San Francisco for example, house prices increased by over 200000 US dollars in the first six months of 2018. This means that the average house price in San Francisco is now over 1.6 million dollars compared with the insane bubble high of 2007 when it reached 895k in US dollars before crashing in 2008. Doesn’t take a genius to figure out that this is another even more preposterous bubble than we had in 2008 and the prognosis for prices in San Fran is extremely grim. Because this is the epicentre of the asset price bubble the boom in the stock market and startups since the fed dropped rates to zero and blasted trllions of dollars into the economy has attracted wealthy Chinese and Russian investors by the boatload and free funding has ramped up activity in the high tech and startups sector. But as the Fed tries to raise rates and overseas investment from China in particular starts to fall off San Francisco is walking a tightrope. This particular tightrope is going to look ever more vulnerable as investors and home buyers become more aware of trends in the majority of global real real estate markets.
In New York, Manhatten is the most expensive and desirable borough in which to live. Here prices have been falling since the start of the year and this trend shows no sign of reversing. Large amounts of new inventory are coming onto the market in Manhatten just as buyers are getting cold feet. As a result of inventory rising and sales falling by almost 20% in the last 12 months prices have come off over 7.5% in the last 3 months alone. Surprisingly this is happening even while the US economy is supposedly firing on all cylinders.
In Beijing, home price sales and prices are starting to stall as the Chinese government has brought in new restrictions on mortgages and introduced buying curbs which has taken a lot of the steam out of the sector and now many developers are offering properties in new developments for sale at asking prices less than those sold in previous phases and less than existing home prices. A huge concern for the Chinese property market is the insane levels of debt that now permeate their economy. Debt to gdp has risen from 141% in 2008 to 256% in 2017. The problem is that Chinese debt levels are high but comparable to developed economies like the USA, UK and Italy. But China is not a developed economy itself and only ranks as a middle income country. This means it has maxed out on debt with a much lower capacity to repay that debt which is likely to strangle growth and economic development in the years ahead. And weakness in China will have huge spillover effects on property prices around the world as Chinese investors spend less on overpriced international real estate. Interestingly the IMF has identified 43 historical instances where the credit to gdp ratio increased by more than 30% in any 5 year period. All but 5 of these resulted in a financial crisis or growth slowdown. Whats makes the odds even worse for China is the fact that debt was already at an elevated level in 2008 and debt to gdp has risen not by 30% since then but by almost twice that amount at 54%.
This brings us to London. London real estate transaction volumes have just dropped back below 2007 levels even though house prices have risen by 62% since 2007 in the British capital. However since 2014 a different price trend has emerged and prices in London’s best boroughs are off about 18% since then. Also developers have delivered large volumes of multimillion dollar apartments to the market in the last few years creating a glut of high end properties in a weakening real estate market while there is still a shortage of property at the low end of the market. Reuters found analysts were expecting price declines this year and next due to Brexit and they rated the chance of a real crash at 1 in 3 over the next few years. Linking the dots globally would suggest that market participants are overrating local factors like Brexit and underrating the importance of global trends. Just like all the other markets we’ve looked at London is in a bubble and Brexit might well just be the excuse the market is using to start letting the air out of this particular balloon.
And what about Dublin? Just this week, headlines emerged about flatlining prices in Ireland’s capital. Again, as seems typical, only local factors are considered to explain these trends despite the suspiciously similar trend of flatlining or falling prices seen internationally. In Ireland, the explanation is that central bank curbs on mortgages introduced in the last few years have made houses unaffordable for new buyers as they simply can’t get mortgages large enough to buy at current house price averages. This is a big factor (but not the only one), but the solution is not to relax mortgage lending standards which will further exacerbate the existing house price bubble. Part of the solution is to maintain standards for lending and let house prices come down to better reflect wage levels. The surest indicator of a bubble is when property price growth hugely exceeds wage growth and general inflation and sadly that has been the case (again) in Ireland over the last several years. The only realistic way out of this trap is to let the heat out of the market and let prices start falling again although the current market narrative does not even recognise the possibility that prices might be in a bubble that needs to subside.
Gold and silver markets have suffered as these bubbles have inflated as investors confidence in central banks has soared in the last several years. As investors have focused on stock markets and property markets getting inflated by insane interest rate policies and trillions of euros and dollars these markets have again bubbled up to stratospheric valuations exceeding the highs of 2007 prior to the last crisis. Given the current setup of the international financial system there is no other way for central banks to respond to economic crisis but by blowing more bubbles. For the last few years this policy has looked vindicated. But what happens as these new bubbles start to unwind? There is clear evidence of this happening already in real estate internationally although we do not yet see it in stock markets. What will happen to central banks credibility when the next downturn is even more severe than what was evaded in 2008? And what will happen to gold and silver prices in that scenario?