2006-03-31

House prices will fall

The Angry Bear Blogsite is everything the world needs - pro-growth progressives warning of the impending doom of over-investment and fiscal stupidity.

Today's posting is about the historical growth of house prices over time. And this is not just about America, but about house prices throughout the western world. And it is not just about house prices for the past few decades, but for the past few centuries.

The graphic, created by Robert Schiller, clearly shows that house prices rise and fall over time, but are not at all determined by population growth. Obviously the reason for this is that as population grows and the demand for housing increases, so does the supply - a process that keeps the prices down.

But the graph also shows that recent price activity has led a growth "spike". In other words, the current price of housing throughout the western world is completely anomolous. Quiddity, a blogger who posted a comment about this article at Angry Bear, points out that the graphic reminds him of Tobin's Q, an equation that has been increasingly used to explain (in hindsight of course) how and when the stockmarket has become overvalued. Similar to the P/E ratio, Tobin's Q is a very useful tool for investors, and there is no doubt that the current housing trend is unsustainable.

But, of course, that doesn't mean you should sell your house (This means you Dave!). The current market is overvalued because it has been used for speculative purposes, not because there is a massive demand for accomodation. The current housing market is made up of homebuyers, those who wish to take advantage of homebuyers (banks, real estate agents, etc), and people who try to take advantage of people who try to take advantage of homebuyers. It's these third group of investors - people and businesses who buy property solely as an investment in the hope and belief that prices will continue to rise - who will suffer the most when the market crashes. Conversely, those who buy houses in order to live in them will actually be the least affected by this.

So, if you own a house and live in it - stay there and don't sell. Pay back the principal as best you can and don't borrow against the equity since that will bite you badly when the crash happens.

If you own an investment property, however, I seriously suggest you sell it... now.

From the Osostrian School Department

© 2006 Neil McKenzie Cameron, http://one-salient-oversight.blogspot.com/

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7 comments:

CraigS said...

What if it is positively geared?

One Salient Oversight said...

By "positive gearing" I assume you mean that the rent incurred on the house is greater than the interest you pay back on the mortgage.

That's simple - if it's profitable then it should be kept.

The question is whether or not the difference between rent income and interest expenses remains positive. Higher interest rates and/or a recession would make the difference smaller, and even push it into negative territory.

CraigS said...

It was just a hypothetical btw, I'm not fortunate enough to own a positively-geared rental property!

MAXICON said...

Damage already done on the US mkt. the housing prices too will crumble in India and China.

MAXICON said...

Damage already done on the US mkt. the housing prices too will crumble in India and China.

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Nice post. But I would like to raise one point here that how we can answer this question that at present time population is also increasing, demand is also there for houses but still the house prices are not at their optimum level?
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