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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 did so 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 these days.

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 week.


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