The Problem with the Global Real Estate "Bubble"

I think the problem with the Global Residential Real Estate bubble, or at least the one in most developed countries, is there is probably no big reset coming. And even if a big reset of house prices came, we wouldn't like it. Here's why.

Let's first describe the problem

House prices in most developed nations have exploded in the last half century

This growth in house prices increased rapidly since the year 2000. Several factors drove this trend but they can be summarized as 2 key points: rising demand met with limited supply

Rising demand for housing was driven by 3 key things

• Reason 1 and 2: Low interest rates and Quantitative easing (QE)

From 2007-2022, Central Banks around the world cut interest rates to stimulate economic growth. They also printed money and used that money to buy bonds (aka QE).

Some of the money printed went into stocks and some of it went to residential real estate. Low interest rates also made it cheap for consumers to afford to buy houses, which stimulated demand.

• Longer term reason 3: Shrinking household size

Let's do some back of the envelope math here.

In 1911, the population of Australia was 4.46m and in 2021 it was 25.69m

Assuming the average Australian household only had 1 home, in 1911, Australia needed to have 99,000 homes. In 2021, Australia needed to have 10.276m homes!

That means over the last century (which included world wars, pandemics, etc.), Australia needed to complete over 100,000 houses every year to ensure each household has at least 1 home.

More recently, the average household size fell from 2.9 people in 1980 to 2.5 in 2021. Which doesn't seem like a lot but in 1980, Australia needed to have 5.065m homes vs the 10.276m needed in 2021.

While you'd be right to think that population growth explains why Australia needs more houses, consider this: if Australia had the same household size in 2021 as they did in 1980, Australia would need 2 MILLION less homes.

Limited supply of houses

If low interest rates, QE and shrinking household sizes were met with a boom in housing supply, perhaps house prices wouldn't have risen as much in the last 2 decades.

Now that we've described the source of the problem, recall the chart at the start of this article.

House prices haven't risen without end in all developed countries. Relative to Japan, Italy and Spain; the rise of house prices in places like the UK, New Zealand, Australia and Canada seem like a bubble ripe to burst.

If we forget about Japan, Italy and Spain's aging population problems for a second, what else could be the problem with this thinking.

What’s the problem with Global Real Estate "Bubble"?

It’s hard to see how it’d burst as governments all over the world keep pumping air into it.

Why?

A real estate collapse could mean a collapse of other asset prices as most of the wealth of the developed world is in real estate.

And no government wants that collapse on their resume. So, they stimulate demand.

Let's talk about the UK for a bit

Going back to Economics 101: if asked what to do when the price of an asset is rising, you'd probably say, either increase supply, or decrease demand.

If you were a UK minister and the asset was residential real estate, you'd answer differently.

You would look for a way to increase demand. Every. Single. Time.

The UK's general election is coming up. The Tories are worried that high house prices mean the young can’t buy.

So, they propose a state-backed 99% mortgage?for first-time buyers, who would have to put down 1% of the price of a house and the government (aka the taxpayer) would guarantee the extra risk to the lenders.

This is a more aggressive version of the Help-to-buy scheme which the UK introduced in 2013 where buyers could pay a minimum of 5% as a downpayment towards a home while the government effectively lends 20% of the property value interest-free for 5 years to the buyer.

While this seems helpful (I mean, who wouldn't want to pay ￡5,000 upfront for a ￡500,000 home), there are some problems that could arise.

Possible problems that could arise from a 99% state-backed mortgage?

• Price

The first problem is an econ 101 one. As they stimulate demand, this not only pushes up prices for all houses, but particularly for the kind of houses that first-time buyers go for.

Capital Economics found that between the time the UK's Help-to-buy scheme kicked off in March 2013 and September 2014, the price of homes bought by first-time buyers went up 18%. At the same time the price of those bought by home movers increased by less (14%).?

The increase in house prices raised the initial deposit first-time buyers had to pay by ￡1,500 and the income required to get the mortgage on the same property up by 12% - at a time when income had risen only 1.2%.

A subsidy that allows a small number of people to take an early leap onto the housing ladder ultimately shanks everyone coming behind.

• Negative Equity

The second problem is more specific to the 99% scheme: negative equity.

A 1% deposit means that only a very tiny swing in prices puts buyers in the position of owing the bank more than their house is worth.

If you owe the bank more than the house is worth, you have "negative equity". When a person owes more on their house than its current value, it can limit their options for selling, make refinancing difficult, and potentially lead to foreclosure if they cannot meet mortgage payments i.e. you lose the home and the initial deposit.

In summary, house prices are probably not going to reset because governments are going to try to prevent it by stimulating demand. Australia is currently about to launch a "Help-to-buy scheme for first-time home buyers.

But assuming governments would let house prices reset, why shouldn't you want it.

Why wouldn't we like a big reset?

What does a reset even look like?

Now let's talk about the US

Interestingly, since the Global Financial Crisis of 2008/09, on average, about 38% of Americans think it's a bad time to buy a house every year. That is, more than 1 in 3 Americans think that there has been a real estate bubble for the past almost decade and half.

The median house price chart of the US looks like a stock market chart. Just going up and to the right.

For the 29% of Americans who thought house prices were too high in 2010 to buy, house prices have to fall to half what they were at the end 2023.?

Why don't we want house prices to half?

"Everyone has a plan until they get punched in the face" - Mike Tyson

Think of it like Bitcoin

When Bitcoin hit $50/60k, I saw several tweets saying they wished Bitcoin would fall to $16-$20k (where it was a few months prior) so they could buy some. However, when Bitcoin did fall to that price, I'm pretty certain those same people did not buy any.

Why?

Because the conditions that make prices fall are unpleasant and make you lose faith in the asset.

For housing, it's not just faith

The consequences of a halving real estate prices will likely be devastating.

1. Many people will lose their jobs.
2. Current homeowners may lose their homes: Anyone who owns less than 50% of their home will have a mortgage with negative equity. If they lose their jobs, they won't be able to afford their mortgage anymore, so they will likely lose their home
3. Banks and mortgage providers will go out of business: If banks have to foreclose on a home and sell the home for less than they lent, they will have less cash than they lent out. Also, when people lose their jobs, they have to draw on their savings to take care of their costs. If enough people go to the bank for their savings, we have a bank run and banks go out of business. Think SVB
4. The only people that will be able to afford a house when house prices halve is someone with a lot of money in cash with a bank that survives.

But as I said, this is unlikely to happen.

What do I think is more likely to happen?

Well, history and politicians' manifesto (cos I don't think any politician is running on a plan to build a ton of houses) tell us that we aren't likely to see a big house price reset in our lifetime.

Even during the GFC, house prices only fell about 20% from peak to trough, which was huge at the time but not quite the kind of reset people think about when they expect a bursting of the real estate bubble.

We'd likely see small pull backs in house prices perhaps 10-20% but a halving of house prices seems quite unlikely.

Final Thoughts

Why can't we just build more houses? That's a long story for another day. In the meantime, let me know why you think we can't build more houses in the comments.

Speaking of housing supply here's a fun fact:

About 90% of the land in the UK is not built on or developed. While some of it is farmland, the rest... your guess is as good as mine

Don't forget to check out my latest #tbt post here

If you're looking for a book about unlikely events, check out this one I read recently.