The Changing Housing Market - Part One
(You can listen to the podcast
instead. Click the control button to the right.)
Last week I waded into the messy world of political Europe. I
for a very good reason. What is happening to the political and economic
scene in the eurozone is changing the way we need to think about
certain asset classes. This blog is concerned with real estate, and we
are just entering a new phase in the way houses are seen in our
society, and unless you pay attention to what is happening you will be
lost, and even start losing a great chunk of your wealth.
The housing market is changing. I shall have to write a new chapter in
my book on housing markets, and how to understand them. If you haven't
read my book, you wont be able to understand the housing market at all.
You can get a copy here:
Two aspects of life have changed drastically over the last decade in
the more economically advanced nations of the world. The first is the
catastrophic fall in interest rates. The second is the continuing
insanity and uncertainty that creeps into every aspect of economic life
Let's clarify what I'm talking about first.
Traditionally, people bought houses with money. That meant only the
rich could own property. The poor were effectively vassals of the rich.
With the advent of the twentieth century this pattern of ownership
changed, and changed drastically as the century wore on. The big mover
was the introduction of facilities for buying things with income rather
than with capital, what we now call mortgages.
In earlier times a mortgage was a straight cash deal, usually involving
poor management by a rich owner, who, more often than not, defaulted,
and lost the property. In other words, the mortgage was the prelude to
a loss, rather than the prelude to ownership.
With the rise of modern mortgages, the real cost of a house was no
longer its price, but the value of the monthly mortgage payment, and
this in turn was dependent upon the current interest rate. If you
borrowed £10,000 to buy a house when interest rates were 5%,
then, over the life of the loan, you would be paying roughly £250
a year in interest on top of your monthly repayments. If the interest
rate went up to 8% you would be paying £400 a year in interest.
For someone with an income of £10 a week that would represent a
substantial increase. It would, indeed, mean bankruptcy.
On the other side of the coin it would mean that as interest rates
rose, so would the cost of a house, and therefore the price would have
to come down to compensate.
The obvious conclusion is that in a mortgage driven world the important
metric driving house prices will be the level of interest charged on
the loan. This leads to all kinds of problems for people who dont
understand how house prices move. The average person sees a low
interest rate environment, and realises that repayments are cheap, and
so rushes to buy a house, usually at an inflated price.
All is well until interest rates start to rise, and that is when the
happy buyer turns into a depressed debtor. The value of his house falls
in tandem with the rise of its cost.
I have always claimed that the ideal time to buy houses is when
interest rates have been high, but have started to fall. That is the
point at which prices are at their lowest, and as interest rates fall,
the monthly cost of the purchase decreases. As the cost decreases so
the price goes up because people can now afford to pay more to service
the loan as the interest element is dropping.
If you buy when interest rates are low, you buy when prices are high,
and the monthly cost can only increase when interest rates rise. This
means you get hit with a double whammy. That's a stupid way to buy a
big asset, but that's what most people do.
Interest rates are currently at their lowest ever in recorded history.
Not only that, but we have the insane situation where the three largest
economies on the planet are running negative interest rates. What does
that mean? It means either one of two things. Either it means that
money is worth bugger all, or that those economies running such low
rates are totally bankrupt and can no longer pay more sensible rates
for money borrowed.
Let me remind you of the legal definition of bankruptcy. It has nothing
to do with debt, but everything to do with obligation. You can be in
debt as much as you like, but not be anywhere near bankruptcy. The
definition is: not being able to pay your debts as they fall due. If
you roll over your debt, it doesn't fall due, and you live to fight
another day. That's what governments have been doing for the last few
decades. In short, all the world's debt is hanging by sky-hooks.
Can this go on much longer? Maynard Keynes once famously remarked that
markets can remain irrational longer than investors can stay solvent.
This situation may last a heck of a long time, but at some point the
whole edifice has to collapse. The serious problem in life is not
knowing when this collapse is likely to take place, and all financial
transactions are currently done in this realm of uncertainty and sheer
stupidity; which brings us right into that second problem I mentioned
at the start of this foray.
How can anyone make any sensible decisions about the future when the
situation is insane to start with, and one doesn't know how much longer
the insanity will last? Tomorrow isn't a problem, it's the next day
that's a worry.
The question that taxes the brains of those who deal in real estate is:
how do we carry on in business while at the same time minimising risk?
And, for the rest of us, how is the answer to that question going to
affect the housing market going into the future?
We'll attempt an answer in Part Two of this investigation. See you next