Housing bubbles

Is the New York (indeed, the US) housing bubble going to burst? A look at the

situation in the UK would suggest that it isn’t. Interest rates have already

started rising

there – but a new

report says that 25 or 50 basis points here or there is going to make no

difference, and that rates will have to double before the mania is

controlled.

What’s going on? The average UK house price is now increasing

at a rate of £1,100 a week: that’s $2,000, near enough. Capital

gains on housing are generally tax-free, which means that a worker would have

to be earning a six-figure salary – in pounds

sterling – just to match the amount that the average homeowner is

making from just sitting in their property as it appreciates.

It’s worth remembering, too, that all these numbers are UK averages: insert

whatever insane multiplier you like to get the equivalent numbers for London.

But to take Tony Blair’s old

house as an example, the PM sold in 1997, when he moved to Downing Street,

for £615,000; it’s now back on the market, listed at £1.69 million.

In other words, if he’d retired instead of becoming prime minister, he’d’ve

made £1.08 million – just under $2 million – from owning a

six-bedroom in Islington. That’s more than he’s made as PM.

The bubble is being driven, it would seem, by people known in the UK as "buy-to-let

investors" – basically, individuals who buy houses not in order to

live in them, but rather to rent them out. Historically, this market has behaved

rather like a bond market: given a set rental income and a set mortgage rate,

it’s easy to calculate how much a house should be worth. More recently, however,

buy-to-let investors have been behaving more like equity investors, who treat

rental income more like a welcome stock dividend than as the main reason for

buying the asset in the first place.

Whenever there’s a housing bubble, prices always rise faster than rents. We’re

seeing that in New York: it’s been a long time since you could cover mortgage

and maintenance costs by renting a place out. The UK is the same way, but the

buyers don’t care: even if they have to pay some of the mortgage costs themselves,

they’re making so much money in capital appreciation that it doesn’t matter.

This kind of thing isn’t really happening in the US to nearly the same extent.

The housing market is something touted in late-night get-rich-quick schemes

on the television, not a respectable way to build a nest egg. But consider a

student who’s just graduating from NYU. If that student, or her parents, had

bought a place four years ago and sold it now, there’s a good chance that the

profit could cover not only the mortgage and maintenance costs, but tuition

fees as well. If you start off rich enough, it would seem, you can essentially

go to college in New York for nothing these days.

Just like any other asset bubble, the longer this kind of unsustainable situation

goes on, the more people pile in, trying to get rich quick. It’s easy: buy a

$1 million apartment today, with $100,000 down and a 90% mortgage at 6%. Watch

it go up by 75% in two years, and sell it for $1.75 million in two years’ time.

You’ve spent $108,000 on mortgage costs, say another $24,000 in maintenance

costs, and a bunch more in legal fees – say $150,000 all in all. Your

total investment: $250,000, including down-payment and costs. Your total return:

$1.75 million minus $900,000 in mortgage equals $850,000. Net profit: $600,000,

or $300,000 a year: call it $25,000 a month. Oh, and you spent nothing on rent

the entire time. Sound attractive?

Of course, you’d make even more if the mortgage were smaller and you paid more

of the upfront cost in cash. So you take your $600,000 and use it as the down

payment on somewhere else – and so the cycle continues. Even if you allow

yourself $100,000 a year for living expenses, you can rapidly make millions

by flipping properties in a bubble economy.

This sort of behaviour is quite common in the UK; it’s barely even beginning

here in the US. Very few Americans buy property in order to become rich; most

still do it for the old-fashioned reason of needing somewhere to live. The frenzy

of apartment-buyers in Manhattan is not a slathering horde of speculators falling

over themselves to get a piece of the property-market action: rather, it’s a

bunch of stressed-out professionals desperately trying to find somewhere they

can afford to buy.

Look at those UK base rates again. They’re at 4.25%, compared to just 1% in

the US. Even if we get 325 basis points of tightening, we’ll only be at the

same place that the UK is now, and the UK’s rates are clearly well below the

level needed to decelerate house-price inflation. In other words, don’t count

on the Fed to precipitate a housing-market correction.

Sooner or later, of course, property prices will come down: they can’t keep

on running away from rental incomes indefinitely. But they’re a bit like the

US current-account deficit: unsustainable in the long term, but showing no sign

of decreasing any time soon. So long as the economy continues to expand, my

guess is that people will continue to feel comfortable putting their money into

bricks and mortar – and increasingly, they’ll be doing so as an investment.

After all, we’re four years on from the dot-com crash, and property is the only

asset class which has done very well in good years and bad.

So, what would I do in this market? Buying property is very expensive –

and, in the long term, I believe, it could prove to be extremely painful. Does

anybody remember negative

equity? Maybe the best thing to do would be to start a new blog, devoted

to the excesses of the New York property market. That should be bound to do

well. I’m not good at coming up with names, but curbed.com has a nice ring to

it. I haven’t checked it out, though: maybe someone else has got there before

me?