Housing Bubble Facts and Figures

Housing Bubble Facts and Figures:
http://globalhouseprices.blogspot.com/

What is a housing bubble?
A housing or real estate bubble occurs when (mal)investment in housing causes prices to increase rapidly to a level that is unsustainable. Bubbles are usually characterised by prices that rise so high they are no longer a reflection of true underlying asset value, rather a reflection of expected gains based on recent history. The process is concluded with a correction which results in prices eventually falling to reflect their underlying value or a reversion to their mean.

Is there a currently a housing bubble?
Consider this chart of U.S. home prices, population, building costs, and bond yields (Irrational Exuberance, Robert Shiller). Shiller shows that inflation adjusted U.S. home prices increased 0.4% per year from 1890–2004, and 0.7% per year from 1940–2004. In recent years, however, house prices have accelerated upwards away from the other elements.


What causes a housing bubble?
In the case of the current housing bubble, it is driven by a number of factors including:
-Low interest rates along with loose lending standards and creative financing - these factors have conspired to embolden an entire generation of home-buyers who would have otherwise not qualified or even considered buying homes.
-Herd mentality and speculative investment - as the bubble gathers steam and draws in more participants, a self-reinforcing cycle of speculation and investment, coupled with the laws of supply and demand, precipitates more price rises, which in turn encourages further herd investment and speculation.
-Expectation of further gains - in bubble markets, prices become detached from reality and soon become irrelevant, the expectation of further price rises is all that matters when participants become caught up in the mania.
-Enthusiasm for home ownership and investment in property as an asset class - many people, particularly those that are less sophisticated and knowledgeable financially, prefer residential real estate for reasons such as it's tangibility, familiarity and simplicity. There is also a common misconception that 'house prices never go down'.

How do you quantify housing affordability and values?
A method of quantifying housing value is the Price/Earnings (P/E) ratio as commonly used in valuing shares. A housing P/E ratio is calculated by dividing the house price by the net income or rent less expenses.
Using this method would yield negative results with the overwhelming majority of properties in the current market due to the fact that rents generally do not exceed expenses or carrying costs.

Traditional methods of valuing housing affordability include the price to income ratio - this is the ratio of the median house price to the median income for a particular area.

Ratio of house prices relative to average wages in Sydney, Australia. (Datastream, AMP Capital Investors)

The following table lists the 20 most unaffordable housing markets in the world. The median multiple figure is derived from median house prices vs median incomes in each particular city. For example in Los Angeles it takes 11.2 times the median annual income to purchase a house valued at the LA median price.

From the 2nd Annual Demographia International Housing Affordability Survey (2006)

What happens when a bubble bursts?
History is the best guide in this case - a textbook example is the Japanese housing bubble which occured in the 1980s, we can study the period following the bursting of this bubble to get an idea of what might happen again.

The following chart shows Japanese house prices (1980–2005) inflation-adjusted, compared to house prices in the United States, Britain, and Australia (1995–2005).

At the peak of the bubble the Imperial Palace in Tokyo was worth more than the entire state of California.


The time after the bubble's collapse is known as the 'lost decade'.


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