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Housing: Taking A Bubble Bath To Reality


Hugh Pavletich
Co author
Annual Demographia International Housing Affordability Survey
New Zealand
September 29, 2008

The major reason for initiating the Annual Demographia International Housing Affordability Surveys back in late 2004 with Wendell Cox of Demographia, St Louis, USA - was to illustrate to Australian’s and New Zealanders in particular at the time - just how distorted their urban housing markets were in comparison with responsibly governed urban markets throughout much of middle North America (Canada and the United States) – where housing does not exceed three times gross annual household incomes.

The “Harvard University JCHS Median Multiple Tables” illustrate this as well.

Policymakers in both Australia and New Zealand chose instead to ignore the significance of “housing bubbles”, allowing these bubbles to further inflate – and collapse. They will therefore need to be prepared to deal with the consequences – in social, political and economic terms going forward.

They will soon learn too – that Governments and Reserve Banks do not have the capacity to arrest the necessary adjustments of these housing bubbles.

The only questions policymakers will need to ask themselves going forward is – (a) to what extent are they going to dither compounding problems and allow the residential construction sectors to collapse – and (b) – when do they intend to allow for the supply of affordable land on the urban fringes, coupled with appropriate debt financing of infrastructure, so that housing at or below three times annual household income can be built.

This will require State / National politicians to deal “head on” with the difficulties too many Local Authorities are having in meeting their social obligations to ensure the provision of affordable housing.

On a “build rate per 1000 population” basis – California during 2008 will generate less residential units than it did on average through each year of the 1930’s. It is likely the same situation in the United Kingdom currently. Both have current build rates of less than 2.0 units / 1000 population. Around 3.0 / 1000 is required for replacement (the US is currently only building at the replacement rate overall).

It would be fair to say that the prospective buyers generally (“bubble bunnies”are rapidly becoming an extinct species) and the finance sector globally, will be waiting patiently until housing stock can be provided, at prices people can realistically afford (example – “Houston Association of Realtors latest Monthly Report”). It seems extremely unlikely the finance sector will be in any hurry to provide “fuel” for any further housing bubbles – as the costs of the currently deflating bubbles to the survivors become increasingly apparent.

The unfortunate reality is that housing bubbles are extremely appealing to most people – as inflating bubbles are the closest most will come to “wealth creation” – even if it is an illusion – and an extraordinarily dangerous illusion at that. This is explained within “Getting performance urban planning in place” and within my Op Ed on “Planetizen”.

In essence – by playing this game - these “bubble bunnies” become “mortgage slaves” on the self inflicted road to poverty.

Politicians are attracted to inflating housing bubbles as well – for their capacity to generate short term "bubble revenue" and allow spending to get out of control. The State Government of California is currently grappling with the downside of this – as are increasing numbers of other Governments globally.

Unfortunately – too many within the economics, urban planning and property appraisal / valuation professions – who have been "schooled" in markets, but not actually "educated" in them with practical experience – have failed professionally - by not informing policymakers and the wider public of the real costs and consequences of housing bubbles. Indeed – many have been more than willing to act as "cheerleaders" for these bubbles.

Experienced property development practitioners ("market developers") know to exit bubble urban markets as soon as possible – because in reality with land and construction inflation, they are in real terms paying tax on illusory profits and left holding "bubble value" land and property, which will crash at some stage. So if their development businesses do not fail because of cash flow problems in attempting to debt and equity finance the inflation – the collapsing bubble values will finish them (and their financiers) off in the end.

The "market developers" are soon replaced with the brave new breed of "planner developers" – who with their bankers / financiers – appear blissfully unaware of the risks (a word recently "rediscovered"in the finance sector) of playing the "bubble game" (with the "stack up merchants" in the investment / speculation sector – who convince themselves that property will inflate indefinitely). These "planner developers" are also willing to take on additional substantial risks of capitulating to urban planners and local politicians romantic ideas (much time is spent together having "visions")–something "market developers" strenuously resist, as the latter are acutely aware of their social and commercial responsibilities (don't go broke and hurt people) and the heightened risks involved, should they capitulate.

"Market developers" view reputation as their most important "asset". The reality is that "reputation" is a far more robust consumer protection than "regulation".

The very necessary ability a "planner developer" requires, is the capacity to engage in "romantic rhetoric" – as this brilliant article (Irish blarney at its best!) "Sunset on the property boom - The Irish Times - Sat, Sep 27, 2008" illustrates.

In New Zealand, with a population of just 4.3 million, where around 32 finance companies have failed to date, "planner developers" are experiencing some considerable difficulties, as illustrated with "Kensington Park", "$450m housing project crashes - 22 Sep 2008 - NZ Herald: New Zealand National news". The developers letters to "owners" and "contractors" make for those not familiar with "development reality" – instructive reading as well. Understandably New Zealand is in recession as outlined within the UK Financial Times article "New Zealand falls into first recession in 10 years" . This has been a "phony boom" – fueled in large measure by a housing bubble.

Kensington Park is only one of many residential developments currently experiencing "difficulties" in New Zealand.

The scale of the housing bubbles globally are unprecedented (refer Demographia Surveys and Harvard Median Multiple Tables.

Yet surprisingly – there have been no estimates made of the quantum of "bubble value' of inflated urban markets globally. The figures that follow should be considered at best "rough estimates" – and it is hoped that researchers, with the recourses available, will generate more rigorous research on this important issue. In particular Reserve Banks, Government Housing Agencies and business / finance media.

In attempting a "rough estimate' of the extent of "housing bubble value" globally – let's start with the United States with a population of 305 million and 2.6 people on average per occupied household (refer "US Census information" – which indicates that there are 117,300,000 occupied (64% owner occupied – 36% rented) – plus an additional approximately 10,000,000 other / second homes – 127,300,000 residential units in total. In the Ist Quarter 2007, the average price peaked at $US322,100 – so that the total (rough) estimate value peaked at $US41 trillion –the usually occupied 117,300,000 units near $US38 trillion.

To obtain a rough estimate of "real value" - the Houston Association of Realtors latest "Monthly Report" (click Homes for Sale – go down right side to Market Report) for August 2008 (released Sept 3, 2008) is of some help – as in the latest Demographia Survey, the Median Multiple for this urban market was found to be 2.9.

Above 3.0 Median Multiple should be considered "bubble value".

During August 2008, the urban market of Houston with approximately 5.6 million people and 2,000,000 residential units sold via the Houston Association of Realtors - 6641 residential units (all types) for a Total Dollar Volume $US1,435,000,000 –indicating that the average price was $US216,081 (median price about $US160,000).

As indicated earlier – the average price nationally in the United States peaked at $US322,100 and with the Houston average currently at $US216,081 this would suggest that the difference of $US106,019 is roughly "bubble value". To be more accurate, it would be more appropriate to go back to the February 2007 average price in Houston – and line this with the US national average price. However – in using these latest "average figures" as a base –it compensates for the slightly lower household incomes in Houston.

Even with these slightly lower incomes – Houstonians generally have a better standard of living than New Yorkers as explained by Professor Edward Gleaser of Harvard University within “Houston, New York Has a Problem by Edward L. Glaeser, City Journal Summer 2008”.

Houston's two million housing stock is the equivalent of less than 1.3 times its GDP ($US317 billion in 2005 according to the BEA of the US Department of Commerce). It would appear that housing markets should not exceed the equivalent of 1.5 times GDP / GAP. If they do – this suggests major structural distortions in a local economy.

It would appear that approximately $US6 trillion of housing "bubble value" has evaporated in the United States to date – in assessing price movements as reported by Case Shiller and the National Association of Realtors.

In rough terms – this would suggest that there was approximately $US13.5 trillion of "bubble value ($US106,019 x 127.3 million residential units) – the equivalent of the United States GDP at $US13.5 trillion approximately (2007 figures).

In nominal terms the United States with a 2007 GDP of $US13.5 trillion is 25% of the world economy at $US54.3 trillion.

California – with its 13,300,0000 residential stock and population of around 37 million, appears to have generated approximately $US6 trillion of "bubble value", with around $US3 trillion evaporating to date. At $US6 trillion, this would represent 44% of the total United States "bubble value" of $US13.5 trillion. A remarkable achievement - when California's population is 12% of the United States total of 305 million.

This illustrates how other factors, such as population growth and excess liquidity (Did automobiles inflate? No. New automobile prices in the United States actually fell by 2.5% in the past 12 months)) are "secondary" to the major issues of land supply and infrastructure financing. The law of supply and demand is the key issue.

Assuming that United States housing represents 25% of the value of housing throughout the rest of the world – this would suggest that housing globally may have reached a total value of at least ($US41 trillion x 4) of $US164 trillion –with at least (US13.5 trillion x 4) $US54 trillion of this being "bubble value".

The "bubble problem" of the United States is not as severe as it is in most other Anglo countries - as illustrated by this year's 4th Annual Demographia International Housing Affordability Survey - with Canada's overall Median Multiple 3.1; United States 3.6; Republic of Ireland 4.7; United Kingdom 5.5; Australia and New Zealand 6.3.

The problems in the United States have been "amplified" by non recourse lending in approximately 25 States (problems arise – just throw the keys back at the Bank – "jingle mail") and the opaque nature of mortgage securitization generated by the finance sector (with the attractive churn fees) – where under the stress of above average "on the ground" defaults by borrowers, these securitized products collapsed substantially in value. Yet rather surprisingly – there has been no talk to date in the United States of what would appear to be the obvious need to "unbundle" these securitized products in an endeavor to restore some sorely needed value to them.

Instead, there appears to be a certain hysteria to "re – liquefy" the finance system, with a further $US700 billion bailout (bringing support to date to approximately $US1.5 trillion in total). Further to this - Bill Gross of Pimco is of the view that US Banks need a further $US500 billion of fresh capital as well.

One is in awe at the ability of urban planners and the finance sector (who prior to the bursting of the bubbles referred to themselves as "Masters of the Universe") - in their ability to mess up something as simple as "house mortgages".

Rather surprisingly too – there has to date been no information on the average foreclosure costs of urban markets and States within the United States – so that the differences between the "on the ground" foreclosure costs and how these are amplified when mortgage products are securitized – can be assessed. It would appear that the Total Dollar Volume of foreclosure losses in Texas are running at around 5% of those of California – for example.


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