As safe as? (House prices)

FOR all the newspaper space devoted to stockmarkets, households around the world have far more of their wealth tied up in property than in shares. American households' shareholdings briefly surpassed the value of their houses in the late 1990s. Now they have about $11 trillion-worth of shares (held directly or in mutual funds), compared with almost $14 trillion in housing. In other countries, housing is even more important. In rich countries as a whole, individuals own $23 trillion in equities, but perhaps $40 trillion in property.

Property is thus the world's biggest asset class, yet timely data on house prices in different countries is hard to find. That is why, earlier this year, The Economist launched its global house-price indicator: a set of house-price indices for 13 countries, going back to 1980, both on an average nationwide basis and for big cities. It is time for a mid-year update.

Almost everywhere, house prices continue to outpace inflation. The exceptions are Japan, where house prices are now in their 11th year of decline, and Germany, where prices have been more or less flat since 1992. Britain has risen to the top of the house-price inflation league, with prices up by over 20% in the year to July, double the pace of a year ago. Australia, Canada and Spain have also all seen price gains of at least 10% (see table).

Average house-price inflation in America has slowed to around 7%, from 9% in mid-2001—a rise, still, of more than 5% in real terms. American house prices have risen by more in real terms since 1997 than in any previous five-year period since 1945. The National Association of Realtors says that house-price inflation has accelerated strongly in many cities in the second quarter. New York, Washington DC and Los Angeles all saw rises in median house prices of 18-22% over a year earlier.

At the other extreme, house-price inflation has slowed sharply in Ireland, Sweden and the Netherlands. These three countries had among the fastest price increases in real terms over the previous five years, and were starting to look distinctly frothy. Irish house prices rose by an annual average of 20% between 1996 and 2001; in the year to June prices rose by just 5%.

Chart 1 compares the change in house prices with the fall in share prices since March 2000, when the stockmarket bubble burst. The canny British investor who sold all his shares in early 2000 and bought a house would have enjoyed a 40% gain in his wealth, compared with a loss of 35% had he stayed in shares.

If 1980 is taken as a starting-point, however, equities have risen by more than house prices everywhere, despite the bear market (see chart 2). Martin Barnes at the Bank Credit Analyst, a Canadian research firm, has tracked total returns from housing and shares in America over a longer period, including rental yield and dividends. The total return from investing in property consists not only of a capital gain, but also a rental income or benefit from living there (you would otherwise have to rent somewhere else). Mr Barnes finds that investment in American homes massively outperformed shares between 1960 and 1980, but then did badly from 1982 to 2000 (see chart 3). Now housing is outperforming once again.

Unlike most equity investment, most homes are paid for by borrowing; interest payments may offset the rent. But the use of leverage can also greatly boost the return on your initial stake. Suppose you invest $20,000 in shares, which after five years are worth $40,000, including reinvested dividends. That implies an average annual return of 15%. Alternatively, you could use the $20,000 as a deposit on a $100,000 house, which then rises by an average of 7% a year over five years, to $140,000. Assume for simplicity that mortgage-interest payments and maintenance costs exactly offset the rental income (or the benefit of living in the house). Then comparing the total capital gain of $40,000 with the initial stake of $20,000 gives an annual return of almost 25%.

The more favourable tax treatment of housing adds to its attractions. In many countries, home owners get tax relief on mortgage-interest payments; more important, owner-occupiers are exempt from capital-gains tax. Against this, the costs of buying and selling a house are far bigger than the cost of trading shares. Taking all this into account, the net return from property, over long periods of time, has in many countries exceeded that from shares.

Traditionally, shares and houses have risen and fallen together. Yet house prices have risen as equities tumbled over the past two years. There are two explanations. With interest rates at 40-year lows, mortgages are unusually cheap. And people increasingly see property not just as a roof over their head, but as the only way left to earn a decent return on investment.

With the value of mutual funds (unit trusts) shrinking, and future pensions looking less secure, many Americans and Britons now see their homes as, in effect, a part of their future pension. They are borrowing more either to buy a bigger house or to buy a second property to let. When they retire they can unlock their wealth in several ways: by selling and moving into a more modest house, by taking out an annuity against the value of the property, or by selling an investment property.

A recent study by the Milken Institute in Los Angeles suggests that, in America, housing has replaced gold as a safe haven in times of uncertainty. This, they say, is why investors have poured money into property as the stockmarket has slumped. The authors find that, from 1945 to 1980, the share of property in households' total assets was positively correlated with GDP growth. Since 1980 they find a negative correlation: housing becomes more attractive at times of slower growth. Until the 1980s, households invested more in housing as equities rose; as shares fell, they put less into housing. By contrast, the recent fall in share prices has seen more money move into housing.

One reason for the change since 1980 is financial deregulation, which has allowed mortgage rates to vary more over an economic cycle, making housing more affordable in downturns. Another is that financial innovation has made property an asset that is easier to tap. A home owner may now convert capital gains into cash by borrowing against the rising value of his house. Home-equity withdrawal (the increase in borrowing in excess of new investment in housing) is running at record levels in both America and Britain.

There are reasons to think that the increased interest in property as an investment is here to stay. Yet there is also a big risk that investors, burnt by the stockmarket, are now overinvesting in housing. The market for housing is almost as prone to irrational exuberance as the stockmarket. And a housing bubble is more dangerous than a stockmarket bubble, because it is associated with more debt. A steep fall in house prices would harm the global economy far more than a slump in share prices.

The best gauge of whether house prices are overvalued is the ratio of house prices to average disposable income—the equivalent, as it were, of the price/earnings (p/e) ratio for shares. In America and Britain, this ratio is now close to its peak of the late 1980s, and the ratio is flashing red in some cities, such as London and Washington, DC. In Ireland and the Netherlands, the ratio is at a record high.

House prices cannot continue rising at today's pace. Yet unless interest rates rise sharply, which seems improbable in the near future, most economists reckon that prices are more likely to flatten off than collapse. Prices appear to be levelling off in London as well as in parts of America.

American house-price inflation is likely to slow, yet Mr Barnes expects that housing will continue to outperform shares. The previous two peaks in the ratio of house prices to income happened, he says, when the p/e ratio for shares was low, making shares cheap relative to housing. Today, shares look overvalued, which boosts the relative attraction of housing.

All this means that house prices might continue to rise for a while yet. But the higher they climb, the more households' debt will swell. The real housing bubble in America and Britain is not the rise in house prices, but the growth in mortgage debt, which is at record levels in relation to incomes. The optimistic view is that, with interest rates at 40-year lows, households can afford to borrow more. Still, home buyers may be underestimating the true cost. Interest rates are low because inflation is low. But that means that borrowers can no longer rely on inflation to erode their debts, as it did in the past.

At the very least, households hoping that ever-rising house prices will provide generous nest eggs are likely to be disappointed. At worst, the risk is that prices in many countries may take a tumble. Falling house prices, massive debts and low inflation: now that really would be an unpleasant cocktail to contemplate.

A concern I have is that the average household in the Los Angeles area (and many others) cannot afford the average priced house.

For example, I earn $100k a year, which is more than 95% of California's population. And yet the most expensive house I could finance would be about $300,000. The average house in my area is $500,000-odd. And I live in the "cheap" Valley; the Westside, where I'd much rather live, is pricier still.

I don't think the average homeowner in LA would be able to buy their house back today. And that scares me, since it means either incomes have to grow to match home prices, or home prices have to collapse.

The latter seems more likely. On the other hand, I've thought this virtually since the day I moved to California, and yet home prices have increased enormously since then.

I'd love to hear people's thoughts about this, since the present situation simply doesn't make much sense.

Unlike equities, housing is a local market--so risk will vary by locale. The big risk is to those of your neighbors in the 500K McMansions who have hollowed out their equity and refi'd with an ARM. If the economy goes South, or interest rates rise, and selling pressure takes over, who's going to buy when all those places hit the market at once?

I'd sit tight and save if I were you. Those expensive places may be a glut at 300K in the not too distant future..

I don't know if "bubble" fits or not. But, I know housing prices can and do tank from time to time. I understand California has had a good run up, but then, so did the NASDAQ.

My guess is that you'd find that lenders are willing to loan you more money for a home than you think. With interest rates as low as they are, your monthly payment can buy a more expensive house than a year ago.

That's not the complete explanation, though. A lot of people can trade up using their appreciated real estate prices as equity for their new homes. That also helps bring down the amount actually financed.

I don't know if it's sustainable or not. The prices simply reflect the demand, and somehow people are scraping together the money to buy homes there. I don't quite understand it myself.

I've lived in housing markets where the prices were collapsing rapidly, and anyone who doesn't believe it hasn't been there. I couldn't afford to move to Southern California, because I'd want a similar house to what I have now, and I'm not going to spend several million bucks to get it.

The current situation benefits the people who already own houses. Mine is worth far more than I paid for it. I also have a rental property that is worth much more than I paid for it. If I decide to move, I will still have the same equity.
People younger than I have higher salaries than I did at the same point in their careers. They can afford houses, too.

But expectations have changed. My parents thought 3BR1BA was fine. I am happy with 4BR2BA2PR. Younger people seem to want either more BRs and BAs or to be closer to city centers (or maybe both).
We're a rich society. When is enough enough?

All I actually want is a dramatic, sweeping ocean view, even with 2br 1ba. And something not in an identikit subdivision. I don't want to be bored to death with my house, even if it is overlooking the dramatic view(*).

Unfortunately, even that modest, humble need is pretty darn expensive nowadays. Like $650,000 expensive, if you're lucky, $850,000 if you're not. If you can even find one.

What I really need to do is increase my earning power. (I'm working on it, honest!) Or wait until the crash.

(*) Surprisingly, the identikit subdivision is not only boring, it's expensive. The general market obviously doesn't agree with my love of 1920-1950 "character" homes or sophisticated architect-designed contemporaries. See ArchitectureForSale for cool houses.

In theory, as long as the Southern California population increases, it should be sustainable. Once it starts dropping or holding steady, watch out!

Southern California does have an outstandingly rich and diverse economy, which is what makes housing here so expensive. Well, that and our legendary rigourous winters, where the temperature can plunge into a positively arctic 50s during the day.

My understanding is that markets in your neck of the woods can collapse when the oil industry does badly, since oil is such a substantial percentage of your economy. This doesn't strike me as a danger in Southern California.

The problem with Southern California is the high cost of housing and this has definitely made many companies look elsewhere for expansion.

On the other hand, as Joel Garreau's 'Edge City' points out, a company rarely moves far from where the CEO wants to live, and - let's face it - this is a great city for CEOs. If you're paid a million bucks a year, it's tough to beat the great restaurants, the recreational opportunities, the wonderful variety of architectural styles to choose from, and the prestige.

But those below your level are going to suffer, even the $100k guys.

Watch out for condos. Here in LA, it's very common to see this equation:

condo payment + association fee >= house payment

(for the cheapest house in the area).

And, I might add, no portion of the association fee is tax deductible.

Be sure you've checked all your options before going condo.

... and the uniformity in tracts looks rather drab.

Confession time: I loathe uniformity. I visited a mediterranean subdivision in Pacific Palisades and it almost made me cry, to see all those uniform boring designs without any heart behind them.

This is my main problem with Orange County. It's richer and shinier than LA, and the government is run about 1000% better, but the housing is too uniform. I love Lido Island, which has a lot of different styles, but entry level pricing is pushing $1 million now, and for a boat dock you're talking about $3.5 million and up. Ouch.

Population experts predict that California will add another 20 million people in the next 15 years or so, and they're going to want to live somewhere.

It's going to be increasingly difficult to build new single-family homes in California because of the no-growth movement out there. I believe that Gray Davis has already announced that California has built its last freeway, ever.

This should keep upward pressure on housing prices, although there certainly is some economic limit out there.

You've probably seen this before, but I thought the Thoureau Institute and its book 'The Vanishing Automobile' were quite interesting. They listed Houston as the epitome of a livable city - it acknowledged that most people wanted to drive, and sensibly accomodated them.

You live around there, don't you? Would you tend to agree?

He has a bunch of policy prescriptions at the end of his book, including variable road pricing based on demand. Personally, I think this would increase the cost of driving to too high levels, while giving our governments a boatload of cash to waste, neither of which I consider to be particularly desirable goals.

I think he was mostly spot on, but road pricing annoys me as a concept due to both low costs and privacy implications for the modern toll collection systems.

I certainly wouldn't consider Gray Davis the last word on any subject, for fairly obvious reasons, but I suspect he's correct, at least for Southern California. The reason is that I think it will be politically impossible to displace anyone from their homes.

Freeways into undeveloped regions are another matter entirely, of course.

Houston is a very liveable city. The whole place is an example of the free market in action because there are no zoning laws. It's the very opposite of micromanaged urban planning like we see on the West Coast.

What Houston lacks is charm. It essentially has none. It's functional, and if the market demand is for a fast food restaurant or an office complex in your area, that's exactly what is going to happen.

The congressman who replaced veteran Bill Archer in Congress, John Culberson, has made it his number one goal to do something about the freeway entering it from the west. We call it the Katy Freeway, but you probably know it as the Santa Monica Freeway. It's a bottleneck because of the explosive growth of the city to the west.

He championed an expansion of the freeway from its current three lanes of thruway in each direction to 24 lanes in total, wide enough to land a Boeing 747 on with plenty of room to spare. Groundbreaking will start in a few months unless the last-ditch efforts of the coalition of leftists stall it.

It is going to be a combination of unrestricted lanes, HOV lanes, and toll lanes, the first time a toll lane has ever been included in part of the interstate highway system. It's a way of rationing access and paying for the project.

I'm not keen on the toll lanes, although I'll glad use them at times if they are substantially faster than the other lanes. The concept is actually quite consistent with the prevalent attitude around here of providing what the market demands.

Interesting link, by the way. I've bookmarked it for further reading.

Well, the Portland planners decided to remove the bulk of their city's charm by mandating four to five story apartment blocks near their light rail, in hopes that someone would actually use it. Need I tell you that nobody did, and yet the housing blocks continue to lack charm?

I think it would make sense to reduce confusion and combine HOV and toll lanes. Having separate lanes for each is going to be difficult for the consumer, I think.

In poking around Malibu real estate, I can certainly say that narrow winding hillside streets do add to charm, and wide ones subtract from it. It's a pity the former are so impractical, and not just for regular traffic - fire equipment takes a real beating, and as you know that's a big concern around Malibu.

Christopher Alexander's masterworks 'The Timeless Way of Building' and 'A Pattern Language' are fascinating because they give ideas for building charm. They are best read together even though that's about a $100 hole in your wallet, even from Amazon. The problem is that they effectively create a parallel view of society, with no big box stores and significantly lower use of the automobile.

I'm not at all clear on whether Alexander's ideas could work in a world that feels a real need for big box stores and SUVs. I don't have any great love for either, but I know the US as a whole has embraced them. I do know that if and when I design a house of my own or have one designed, Alexander's ideas will be very much in use. The books are well worth reading despite their utopian idealism.

Joel Garreau's Edge City is the most reality based book on urban planning I have ever read; he went out and decided to understand how things really worked. It's quite a ride. Unfortunately, what it seems to say is that Edge City lacks charm and is unlikely to find it any time soon.

If I wanted to find a property with pleasant surroundings and a nice view, where would I go in Houston? I would guess that since it's fairly flat, a waterfront property would be my best choice. I'm very curious to see a real world comparison between LA and Houston real estate prices. I don't think it will serve LA very well :-(.

Houston is not directly on the coast, so you can't have an oceanfront view in the city. Galveston is your best bet for that, and it's essentially a suburb of Houston now.

Scenery is not Houston's strong point. While the soil is typically rich and tropical plants are both common and beautiful, it is very flat. There are no places where you could build "overlooking" Houston. Your view is going to be blocked by the closest building to you.

Most of the upscale neighborhoods are built around golf courses and man-made lakes. There are some fairly large lakes in the area, and they are considered the prime location for those who value a scenic view.

ColdwellBanker has a housing price calculator which currently is moving to a new web address, so I can't link it, or even access it. But the example that it provides is that a home in Houston worth $150,000, would cost $508,000 in the Hollywood Hills.

A $150,000 home in Houston is certainly above average, although it's not going to be on the lake or the actual golf course. But a $508,000 home in Houston is likely to be on the lake or golf course, have a swimming pool, tennis court, four-car garage, and at least 6,000 square feet.

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