From: Matthew Robb 
Newsgroups: uk.finance uk.politics.misc
Subject: Re: Castles in hot air -  ECONOMIST
Date: Sat, 18 Oct 2003 10:03:57 +0000 (UTC)

On Fri, 17 Oct 2003 23:55:10 +0200, "tim"
<520061495900.removethis@t-online.de> wrote:

>> THE rapid house-price inflation in many countries over the past few
>> years is clearly unsustainable. But will house prices just flatten off
>> or will they slump? Alan Greenspan, who criticised the stockmarket's
>> "irrational exuberance" long before that particular bubble was fully
>> inflated, is more sanguine about American house prices. He accepts
>> that there are local hot spots, but dismisses the idea of a national
>> housing bubble that could harm the whole economy if it bursts.
>> 
>> In other countries where house prices have been rising, many analysts
>> also pooh-pooh the idea of a bubble. They point out that interest
>> rates are low, so people can afford to borrow more and are therefore
>> willing to pay more for a home. The affordability
>> index-mortgage-interest payments on an average-priced home divided by
>> average income-is still quite low by historical standards in most
>> countries.
>> 
>> There is something in this. First-time buyers who previously could not
>> afford the typical mortgage payment can now get on the first rung of
>> the property ladder.
>
>this is incorrect.  First time buyers, who could get on the ladder 
>with ease three years ago, now cannot (because even with low
>interest rates, the price is too high)
>Even if they could afford to buy, why would anyone buy a 200K
>house if they could rent same for 750 a month?  (the usual reason
>is that they expect a good capital apprecition, but anybody expecting
>that in the current market is a fool - can I part them from their money 
>please?)
>
>I think the rest of your analysis now falls apart completely.

Firstly, it's not his, it's the Economist's - as he shows

Secondly, in May, house price inflation was a lot higher, and first
time buyers were entering the market. 

Thirdly, the rest of the analysis rests on some other data on house
price inflation, which, whether it accords with your theory or not,
remains empirically true.

As below...


>> * The p/e ratio. The price of any asset should reflect its future
>> income stream. Just as the price of a share should equal the
>> discounted present value of future dividends or profits, so the price
>> of a house should reflect the future benefits of ownership-either the
>> rental income earned by a landlord or the implicit rent saved by an
>> owner-occupier. During the dotcom bubble, investors behaved as if
>> profits no longer mattered. Likewise, people today are ignoring the
>> link between house prices and rents.
>> 
>> In America, for example, a p/e ratio of sorts for housing can be
>> calculated by dividing an index of average house prices by the index
>> of rents which is included in the consumer-price index. In recent
>> years, home prices in the United States have outpaced rents, pushing
>> the p/e ratio to record levels, 16% above its 30-year average (see
>> chart 8). San Francisco's p/e is almost 30% above trend. Estimates of
>> p/e ratios for Britain, Australia and the Netherlands point to an even
>> more pronounced bubble, suggesting that house prices in all three
>> countries are at least 30% too high.

>> * The house-price-to-income ratio. The ratio of average house prices
>> to average incomes, which tracks the long-term affordability of homes,
>> is currently flashing red in America, Britain, Australia, Ireland, the
>> Netherlands and Spain. In all these countries the ratio is close to or
>> above previous peaks-ie, levels that preceded previous crashes (see
>> chart 9).
>> 
>> Awkwardly, this ratio is sensitive to the exact measure of income
>> used. In America the ratio of average home prices to average personal
>> disposable income is only 5% above its long-run average. But Ian
>> Morris, an economist at HSBC, a bank, reckons that the ratio of
>> average house prices to median household income is a better measure,
>> because it reflects the circumstances of the typical home-buyer and
>> avoids the distortions introduced by a few very rich people. This
>> ratio is currently at a record high, 14% above its long-run average. 

>> All of the six countries where houses appear to be overvalued
>> (America, Britain, Australia, Ireland, the Netherlands and Spain) also
>> share another bubble-like symptom: an explosion in mortgage borrowing
>> in recent years. Australian household debt has jumped from 55% to 130%
>> of personal disposable income over the past decade. In the Netherlands
>> the ratio has almost doubled to 180% of disposable income over the
>> same period. The average new mortgage there is 110% of the value of a
>> home, because lenders are happy to finance all the purchasing costs,
>> including stamp duty and fees. In America, 21% of mortgages last year
>> were for more than 90% of a home's purchase price, up from 7% at the
>> peak of the boom in the late 1980s. This means that if prices were to
>> drop, more households would be left with debts exceeding the value of
>> their home than were a decade ago. 
>> 
>> A sticky situation

>> Take Britain, where house prices appear to be more than 30% overvalued
>> relative to their long-term trend. If house prices stay constant and
>> wages grow by 3% a year, it will take ten years to bring the ratio of
>> prices to income back to its fair value. Moreover, history shows that
>> after a boom prices usually undershoot their fair value. If the ratio
>> of house prices to income were to plunge to its trough of the last
>> cycle, then even with rising incomes average nominal house prices
>> would slump by almost 40% over four years. That would be overdoing it,
>> but a price fall of 20-25% looks likely.

cheers

matt