How did global real estate become so expensive?

The same question can be asked about real estate in many parts of the world: why has it come to be valued at such a high level by comparison to yardsticks like local average income and rental yield? But let me focus on the UK as an example.

This week I am staying in a holiday rental apartment in Bath in Southern England and it was relatively easy to check on the Internet what the owner paid for this property recently. It cost a little over $400,000 in 2006 and is said to be worth $450,000 now, although I think with prices falling like a stone that estimate would have to be treated with some scepticism.

On my estimation, after all charges and deductions the owner would be lucky to clear $40,000 in rental income per annum, despite the inconvenience of tenants like my wife and I to check in each week and help connect to the Internet, etcetera. That is a 10 per cent return before tax, and after tax perhaps seven per cent. Not a great return and the landlady appears to have over-spent on the two-year old fit-out which benefits us but not her bottom line.

She doubtless bought on the understanding that capital appreciation would be forthcoming. But even the most generous estimate is that prices are falling by 10 per cent, so after tax I am afraid my landlady is losing money and working for a negative return.

Then consider the relationship of property prices to average income. This depends on whose figures you take. But let us say $50,000 a year is the average income in the UK. Then the relatively small property I have rented in Bath would cost nine times the average UK salary. How ridiculous when building societies offer three times salary, plus a hefty deposit is required these days.

House price inflation in the UK has been enormous if you look back over the past three decades. In my home town of Salisbury a week ago I went to look at three houses that I worked on as a building site labourer before going to university thirty years ago. These homes were sold by my father’s company for $36,000 each. Right now they would cost twenty times that amount.

I checked with my mother what our family home was worth at that time and also came up with a factor of twenty as being the change in price since then. Now inflation has been substantial over the past three decades but nothing like 2,000 per cent. My standard measure is the price of a British Rail cup of tea which is up six-fold or 600 per cent.

Why should housing cost so much more? I can accept that the cost of mortgage finance used to be higher. But that can not explain more than half the relative increase. Houses just became far too expensive. Bid up perhaps by a national mania for property ownership. When ‘location, location, location’ became the name of a popular TV series, and not just a piece of sensible advice for buying property, perhaps we should have all been more leery.

However, I did manage to find one thing during my stay in Salisbury that had not change in price in thirty years. I went to visit my local coin and collectibles shop, Castle Galleries, still owned by John C. Lodge a pillar of the community as a youth club organiser when I was a small boy. He sold me two silver bullion coins for $40, exactly what they would have cost thirty years ago.

Mr. Lodge recalled the late 1970s and how people used to queue down the road to buy and sell silver and gold coins in his shop. This summer his stock is running short, and I actually bought his last two silver bullion coins. Retail investors are again buying gold and silver coins as a hedge against inflation which is running rampant in the UK, especially for energy and food.

There is some irony that consumer price inflation is roaring ahead while the country is suffering from housing asset deflation. Until house prices have bottomed out there is little sense in British expatriates buying homes or for any other foreign buyer looking to purchase a house.

Landing here as a summer resident from Dubai I perhaps have the classic perspective of a visitor from Mars in being more objective than the people who live in Britain permanently. There is an asset deflation in progress that will also include a big stock market correction on top of what has already been witnessed and a downward adjustment in bond prices because of consumer price inflation levels.

These are poor times to be an investor in real estate, equities or bonds. And by a process of elimination I believe that brings us back to the one asset class that looks still seriously undervalued. Gold and silver are about to have their place in the sun, and values this autumn could soar much higher than generally believed possible as inflation rages and other assets prices slump.