Is There a Real-Estate Bubble?
As the S&P 500 index and other global equity bourses hit fresh all-time highs, it is important to evaluate whether the markets are getting ahead of themselves, specifically in the housing space, as the housing market meltdown was the catalyst which brought down the equity markets beginning in 2008. Could there possibly be another real-estate bubble that is lurking to take down global equity markets?
A Brief History of Recent Housing Bubbles
In 2008, the housing bubble in the United States, kicked off a financial crisis that led to the great recession. The housing bubble was created by sky high prices, which were buoyed by a deluge of improper loans and leveraged with derivative structures that led to an over-leverage economy. In the years leading up to 2008, loan agreement criteria became very soft, as mortgage originators were compensated by the number of loans they produced, regardless of the credit worthiness of their clients. Many home owners did not have to prove a specific annual income to receive a mortgage, or put any money down when they were purchasing their home.
Fraud began to perpetuate as mortgage bankers were incented to close mortgage loans at all costs. This led to a group of mortgages that were very high risk. At the same time, investor appetite for yield allowed banks to create securitized loans that were focused on baskets of mortgages. These securities were called collateralized debt obligation or collateralized mortgage obligations. These pools were rated by agencies such as S&P, Fitch and Moody’s, at top ratings as they were designed to hold a basket of bonds that only contained a small portion that were considered junk. As defaults began to accelerate, the value of the leveraged securities tumbled bringing down the banking industry which led to a massive stock market crash.
When the housing market in the United States began to go south, securities that were backed by loans that were lent to borrowers that had no skin in the game became worthless. Eventually as defaults started rising, banks that owned CDO’s and CMO’s lost liquidity, and in the case of Lehman Brothers, defaulted.
London Remains Robust
The great recession spread throughout Europe and Asia, as housing markets tumbled during the period from 2008-2010. Europe has its own debt crisis since 2012, which also led to a housing meltdown. This eroded values in Paris and Rome. Housing in Europe is mixed. The most recent data from Halifax shows that UK property values have increased in London by 0.6% to and remain elevated near the highest levels on record. The average home is worth 297,832 pounds. It’s not as rosy in Paris. The French national statistical office revised its Q3 national average down from +1.5% to +1.2%
Today there are pockets around the world where the housing market could still face additional downward pressure. For example, in India and Egypt the recent decline in their currencies could increase inflation to the point where there is demand destruction and people cannot afford to purchase a home. Many banks in India are holding back on loans as stressed debt know makes up 17% of the banking industries portfolios.
In the developed world the housing market is tight, and prices are at record levels, but it’s more of a function of the lack of inventory as opposed to inadequate mortgage lending standards. In fact, U.S. regulation is still very tight, and most people now have to put down at least 20% to attain a mortgage loan. In addition, lending standards are high and a “no income” loan does not exist today.
But there are risks and the share of FHA mortgage payments that are now behind in the 30 to 59 days past due range averaged 2.19% in Q4, up from about 2.07% from Q3. This is still substantially below the 3.77% seen in early 2009.
Not a Bubble Yet
If economic bubble is defined as exuberance, were prices reach levels that are unsustainable because of euphoria, then the housing markets in the developed world is far from a bubble. Demand remains high, even with tight lending standards in the United States, and as wages begin to climb, people will pay more for homes.
Unfortunately, in the wake of the 2008 crisis, many developers declared bankruptcy. There is now a lack home construction, which has led to the lack of supply. With demand on the rise and supply not able to compensate, prices should remain robust.