Housing an obvious investment bubble in the UK and Australia
Posted on 16 June 2010 with 13 comments from readers
British and Australian home owners who think they have beaten the global economic crisis by investing in property are about to suffer a nasty shock as interest rates revert to more normal levels, and house prices fall by up to 50 per cent.
This warning came from legendary US investor Jeremy Grantham talking to The Australian newspaper this week. He saw an ‘unmistakable housing bubble’ in Australia and the UK.
Income multiples too high
‘You cannot possibly miss it,’ he said. ‘The price of housing typically trades about 3.5 times of family income and in bubble it goes to 6 or . . . 7.5 (times). Australia is having one now. You are at near 7.5 times family income . . . which suggests you are twice the size that you should be.’
Mr Grantham predicted the demise of major banks, hedge funds and private equity before the recent global financial crisis, and is considered an authority on investment bubbles. He is co-founder of GMO, one of the world’s largest investment management firms with some $106 billion under management.
‘Bubbles have quite a few things in common but housing bubbles have a spectacular thing in common, and that is every one of them is considered unique and different,’ he noted, citing the British housing bubble of the late 1980s when it was argued that a shortage of land would keep prices rising forever. People always think is it different this time and that is seldom true.
UK house prices crashed in 1991-3. ‘Seven years later in 1997 they hit the lowest multiple of family income since record books started in 1945. It’s always the same old argument, they are not making any more land,’ commented Mr Grantham.
He said that if the UK and Australian housing markets did not return to normal family income multiples ‘it will be the first time in history. Sooner or later the rates will go up and the game is over.’
Gulf buyers beware
For Gulf nationals or expatriates considering a house purchase while the US dollar is strong this ought to serve as a salutary warning. The writing is on the wall in letters ten feet high.
Interest rates are unsustainably low. We have key UK and Australian policy makers talking about the need for inflation to ease national debt burdens. Inflation will also mean higher interest rates in the long run.
Making a long-term investment in a property at this point in the valuation cycle is complete madness and cannot possibly prove to ever be a good investment from any point of view.
Even the argument for greater space for a family is nonsense if it proves to be a terrible investment that permanently damages the domestic balance sheet over a lifetime. Renting is a very good alternative option, indeed the only rational choice.
Renting in these countries is actually an outstanding bargain by comparison to the full cost of home ownership and the massive downside investment risk. Well, Grantham will be shown to be right again. It is not for nothing that he manages more money than Warren Buffett or George Soros.
Absolute price levels
You can also see the housing bubble in absolute price terms. Why should a four bedroom home in a small English town cost $690,000 while a similar unit in Germany can be bought for $310,000? Population density in Germany is not so different from the UK, if that means anything.
Either the German house is a spectacular bargain or the British house is massively overpriced. Consider that the German homeowner is probably richer and surely you have the answer.
Timing this market correction is always the big bugbear but housing is such a long-term investment that you ought to wait for it to happen before even considering an acquisition.
13 Comments posted by readers:
For the UK, he is probably right, but Australia is a unique case. I have looked at some homes there (on the Internet, Slidell is a nice little town, except in the June thru September heat & hurricanes) and they don’t seem overpriced, unless China goes south for quite a few years. Australians look like they are doing quite well digging up stuff and selling it to China. That works as long as the population is small, and labor stays scarce.
Ed Note: different this time for Australia? What happens when China pops?
Yep agree, aussie housing is still a bargain when compared to UK. Shame the place is full of Australians.
The other aspect to consider is that in previous housing “crashes” pricing didnt go down that far. In some areas it did many investment properties just went sideways for years.
The other big benefit of storing wealth in housing is realised when inflation inevitably follows this deflationary period. Inflation has the effect of reducing the value of debt which means your relative equity goes up. Great time to have loads of debt!
Dear Bill,
Do have a look at these few sites before you rush out and buy some Aust RE.
http://www.bubblepedia.net.au/tiki-index.php
look at the graph v the USA
http://www.bubblepedia.net.au/tiki-browse_image.php?imageId=2
And have a read through some of thee articles
http://boombustblog.com/reggie-middleton/2010/06/12/aussi-bubble-video-to-go-with-you-aussie-bubble-speculation/
Well Sandman, it looks like you are correct and really know your stuff. My conclusion of no Australian bubble shows the danger of Google Street View. As I recall, I went down to some random street in some city in Australia to see what it looked like, (cheap travel ) and happened to see a ‘for sale’ sign. I found the listing somehow, and the asking price seemed reasonable. But those graphs are ugly.
Then again, just because prices are way too high in one city, doesn’t mean that that is the case everywhere, especially in parts of the USA.
In August, 2008 I bought a 1,700 square foot (living area) all brick house with an attached double car garage just north of Slidell, Louisiana, for $140,000 in cash. The agent said that the homes originally sold for about $65,000 when new, in 1978. Since lending standards were tighter in Louisiana, we never had a big housing bubble. An identical property two houses down the block, just sold for $145,000. It sold in two weeks. I thought that prices around here would have fallen with all the economic problems, but they haven’t. So I won’t get a break on the real estate tax. Just my luck. You can’t find a brick home that isn’t in a flood zone for less that 140k around here, even with the popped real estate bubble in the USA. I almost bought a $225,000 condo, but decided it was way too large for one person, and I wanted to be able to play my stereo as loud as I want, or watch CNBC Europe until 4:00 a.m. some nights. And I’m stingy, and wanted a nice western facing living area for the afternoon sunlight. Even at only 30 degrees North, the sun sets at 4:57 in late December.
homes originally sold for about $65,000 in 1978 in the UK are ‘worth’ about $800,000 today
I grew up in a small country town in Australia. Today the town has a steady if not slightly declining population, lax planning restrictions, and many thousands of acres in every direction ripe for development…………..oh, and house prices that make no sense whatsoever.
Median household average income in the UK is about £35,000, suggests that current values are 35% above the ‘typical’ 3.5x multiplier.
However the arguments given are lower earners are now excluded from becoming property owners in our ‘progressive’ society. Those at the bottom are given free housing and those on good incomes can buy, those in between – tough luck.
Expectations (driven by the media) are that any price falls will be in real terms and any imbalance will be recertified with a few years of high general inflation.
I have houses in both the UK and US. One big issue with the US is the extremely high property taxes and bad quality of construction. My US house valued at $450k costs much more to run than my UK house valued at $800k when all running costs are taken into account ove last 5 years.r the
I do agree the UK is way over valued and will drop but also feel the UK is a much better place to own a house in if running costs are you main concern. A large part for the drop and low value of US houses is the cost of actually owning them.
If you are rich the UK makes way more sense than the UK to own a large house in for example:
London house 5million dollars is 3k a year property tax
NYC house 5 million dollars is 70k a year poperty tax.
I’ve watched these talking heads and so called real estate experts for 35 years. None of these suits really understand real estate and most have only owned their own home and nothing else. I take my advice from people who are authentic, original, creative and have a history of investment success. That knocks out 90+% of the online and TV pundits.
A small terraced house in the London suburbs that was purchased in 1982 at around £25,000.00 is now worth around £220,000.00. Probably this is the optimal price level that this house will reach in a long time to come.
It is very difficult to compare the reasons behind house price inflation as there are many factors. A house in France for example purchased in 2000 for 150,000.00 Euros is now worth 450,000.00 Euros. Credit rates are also much much lower in the Eurozone.
I have friends in Germany and the German housing market is held back by the banks. You pretty much have to be able to put down over 30% of the asking price to be able to borrow the rest. Most people don’t have that and stay in rented accomodation. Good for those who can buy – bad for those who can’t.
Sydney is now the most expensive city in the world to buy a house. It costs 9.3 income multiple to buy the median house in Sydney
Ed Note: Well there is some logic in this as it is possibly the best city in the world to live in but you are right you do have to be able to afford prices to pay them!
Moved to Sydney 2 years ago from London. Certainly not the best city to live in imo, poor public transport, terrible roads and very expensive cost of living. You will pay 400 – 500 thousand pounds for a small 2/3 bed poorly constructed house in a very dull suburb no where near the beach. I’m watching house prices go down in London with interest…
What has the value of my home got to do with multiples of income?
The value of my mortgage perhaps but not my home. This relationship of income to home value does not reflect the majority of home owners. Investors however…
They should have read the small print, investments can go down as well as up.