Return of the housing bubble

Around the world, housing is fuelling a whole new frenzy of speculation and unrealistic optimism
A man walks past open house signs in front of condominiums for sale in Santa Monica, California, October 17, 2010. REUTERS/Lucy Nicholson (UNITED STATES - Tags: BUSINESS) - RTXTJOL
Return of the bubble
Lucy Nicholson/Reuters

For the past decade American economists Karl Case and Robert Shiller, whose Case-Shiller indices are considered the official barometer of the U.S. housing sector, have regularly polled recent home buyers on where they think house prices are headed. The 5,000 buyers in their survey have proved remarkably perceptive, consistently predicting how far prices would rise or fall a year into the future.

But when they asked buyers where they thought prices would be in a decade, a different picture emerged. Buyers have regularly predicted large and steady long-term increases in home prices. Even in 2009, during the depths of the financial crisis as prices fell more than 30 per cent, buyers were still predicting their homes would likely double in value over the next 10 years.

With this enduring faith in the infallibility of house prices, America’s housing market suddenly seems to be springing to life once more. Nationally, prices jumped more than 12 per cent in January over the previous year, the largest increase since 2006. Prices are up in more than 100 cities, according to real estate data firm Zillow, with increases above 10 per cent in more than 47 major centres.

They’ve been led by massive, some say speculative, booms in areas like Florida, Arizona and California that were the hardest hit in the financial crash. Local buyers are competing with private equity firms who have spent an estimated $8 billion snapping up foreclosed homes to turn into rentals.

Such intense activity has been hailed as proof that the U.S. economy is officially back on track. In his State of the Union address, President Barack Obama urged banks to once again start lending, since “too many families with solid credit who want to buy a home are being rejected.” But stories of investors flocking into housing and of banks under political pressure to approve mortgages sound hauntingly familiar. It’s leading some to warn that a new bubble is forming in American housing, less than five years after the last one burst.

And far from being simply a U.S. story, the new real estate boom is once again looking to be a global phenomenon. Swiss bank UBS warned in December that its national “real estate bubble index” had hit its highest point in 20 years, prompting the government in February to require Swiss banks to hold more capital reserves. Home prices in Norway have quadrupled over the past decade, even adjusted for inflation, with the International Monetary Fund warning the country’s housing market may be overvalued by 20 per cent. Home prices in Hong Kong are up more than 160 per cent since 2008, with the IMF warning of a “risk of an abrupt correction.” Even Ireland, where prices fell more than 40 per cent at the depths of the crash, reported its largest price increase in December since its housing market collapsed.

Then there is Canada’s own housing bubble. Nationally, prices rose 2.7 per cent in January compared to a year earlier, despite major changes last year to mortgage rules and slowing sales. It prompted the IMF to warn recently that the federal government may have to implement a fifth round of tightening on mortgage rules to stem rising household debt.

Excluding the eurozone—where the ongoing fiscal crisis has crippled many key housing markets—home prices rose more than six per cent globally last year, according to international real estate agency Knight Frank.

Like the pre-2008 housing bubble—which also sent house prices skyrocketing in markets as disparate as Spain, Ireland, Denmark and Australia—the current boom is being led by continued low interest rates as countries like Norway and Switzerland race to keep their currencies from appreciating too quickly. But unlike the explosion in U.S. subprime lending that helped fuel the previous bubble, today’s prices are being helped along by wealthy global investors looking for safe havens for their cash, say experts.

For high-end homes, prices are up nearly 20 per cent globally compared to 2009. That’s fuelling a construction boom in places like Manhattan and Miami, where investors have pushed prices up 34 per cent in the past year. Miami is now home to 19 different condo projects, mostly high-end properties, with a total of 7,000 units. London, long a place for the über-rich to stash their cash, has seen prices for luxury homes skyrocket by 53 per cent since 2009. The market is home to an increasingly diverse global clientele with the number of nationalities buying in London doubling in the past three years to more than 70. International buyers are also starting to cast their attention toward Europe’s most troubled markets, with renewed interest in high-end properties in Spain, Portugal, Italy and France. “It’s sort of like looking at a global property monopoly board,” says Paddy Dring, head of international residential property at Knight Frank.

He believes today’s real estate boom is driven by fundamental changes in the global economy, like the abundance of new millionaires in the emerging world and an aging population looking for lifestyle retirement properties. “The growth of wealth in emerging markets is that much greater and the idea of having an asset in a different location, in a different currency, makes very good sense for a longer-term investment,” he says.

But this wouldn’t be the first time since the crash that a sudden frenzy for real estate appeared to signal the start of a global economic recovery, only to turn into another short-lived speculative bubble. California experienced rebounding prices in 2009 and 2010, only to see them fall again in 2011. Denmark, whose real estate bubble burst in 2008, sending house prices tumbling nearly 20 per cent, also saw a sudden spike in prices in 2011 before they resumed their downward spiral.

The idea of a lasting rebound in house prices also ignores the lessons of history, the Yale economist Shiller says in an interview. “There are people who want to say that it has turned around,” he says. “I’m a little on the pessimistic side. There’s too much history of long declines in asset prices after big financial catastrophes.” It is also worth noting that there’s no clear reason why house prices should be taking off now in the U.S. Unemployment actually rose in January, while consumer confidence dropped to its lowest levels in more than a year.

Shiller has charted American home prices from 1890 to 1990 and found that when adjusted for inflation, prices didn’t actually go up at all over the entire 100 years. Add in the cost of maintaining a home and the fact that buyers tend to prefer new properties to older homes and Shiller says in the long run housing makes a pretty lousy investment.

But while the last 100 years have seen house prices stay virtually flat in real terms, Shiller predicts the next century will probably be characterized by more frequent real estate bubbles. People in cities that have seen major real estate booms tend to be more likely to believe that house prices will eventually go up again, he says. So rather than make buyers more cautious, the global housing crash might be driving even more unrealistic optimism. “There’s been a rise in a speculative culture all over the world,” Shiller says. “I think the volatility of real estate may be going up in a long secular path. I don’t believe home prices will go up, but they might be more vulnerable to bubbles.”

If so, homebuyers who think global real estate markets have learned from past mistakes will be in for a rude awakening.