Overvalued Over Developed: When the Property Bubble Goes ‘Pop’

As Jeremy sped through the empty highway in a canary yellow McLaren MP4-12C Spider, he radioed in.

I’ve had yet another brilliant idea. Instead of looking for a hotel, why don’t we just go into the next town and help ourselves to a house.

Richard looked over at him from his red Ferrari 458 Spider and answered: ‘Okay’.

It’s not a bad idea.’ He heard James say through the radio from his Audi R8 Spyder.

So, they did.

The three convertible cars took the next exit and went house hunting. And let me tell you, they had a lot of empty houses to choose from.

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As they crawled through the abandoned housing state Jeremy asked: ‘How about 53? Or 55?

As a number, I prefer 55’ said Richard.

So, they parked their three supercars in front of the white luxury home and walked up the steps with their bags in hand.

Jeremy tried the front door, and it was unlocked.

So, they moved in for the night and cooked a paella for dinner.

This scene above was part of the episode ‘Spanish Supercar Road Trip’ from Top Gear, the British show that tests if cars are actually as good as they claim.

Yet the most striking part of the episode was not the cars they featured, but the fact that it exposed that Spain was full of ghost settlements after the 2008 property bubble burst.

Throughout the episode they perform noise level tests in an abandoned state, they come across several ghost towns and half-finished roads. They even race through an abandoned airport runway.

House 55 was in a town called Seseña, about 40 km from the capital, Madrid. The town became the poster child for the 2008 property bust.

The aftermath of the bubble was a much different scenario than in 2003, the year that arrived in Spain after spending a few years living in the US.

The place was buzzing then on a credit boom and high immigration.

There was too many people and not enough homes, we heard. It was why home prices were booming.

And Spain kept building.

There was construction and cranes everywhere.

By the time Top Gear filmed the episode unemployment had soared, people were leaving the country in search of jobs and there were abandoned developments everywhere.

But now once again Madrid’s property prices are starting to pick up. UBS now considers the capital overvalued, as you can see below.

The Rum Rebellion - 5-09-19

Source: UBS

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In fact, UBS considers that plenty of cities around the world are either overvalued or at bubble risk.

Take a look at the following graph, also from UBS. Here is how many years it will take a skilled worker to buy a 60 sqm apartment. As you can see, the number has been increasing in most cities since 2009.

Years for Skilled worker to buy house - Property Bubble - 5-09-19

Source: UBS

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People have to work more to afford a home. Salaries haven’t been growing and house prices have detached from reality.

What’s the solution for affordability?

The International Monetary Fund (IMF) recently offered one for Canada: build more houses.

From the IMF blog :

People who can afford a down payment typically borrow as much as they can to get a foothold in the market—stretching themselves financially and contributing to Canada’s record-high levels of household debt.

So, how can governments help make housing affordable? Our latest staff report suggests boosting housing supply to meet demand.[…]

Homebuyers have been able to borrow more money over time due to rising incomes and a significant decline of mortgage interest rates over the past two decades. As a result, increases in borrowing capacity have been quickly reflected in higher house prices.

This has happened in Toronto and Vancouver, where house prices have increased much more than implied by attainable prices, resulting in over-valuation for an extended period.

Overall, this has contributed to a rise in the size of down payments as a share of income and a push towards higher loan-to-value ratios.

But, with mortgage rates not in decline and incomes growing slowly, homebuyers in Canada will not be able to borrow as much to buy a house. This will weigh on housing demand and bring about a decline in house prices that will improve housing affordability. There is a risk, however, that the decline in house prices could take the form of a sharp and disruptive price drop.

I see a couple of problems with this strategy.

For one, Canada’s population is ageing. Check out Canada’s population pyramid, looks more like a tower.

The Rum Rebellion - 5-09-19

Source: Population Pyramid

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So, who would buy all those new homes?

The other is that there are a lot of homes already sitting empty.

As Point2homes wrote in August:

In 2016, there were 1.34 million empty and temporarily occupied homes in Canada. But the country’s housing problem extends beyond foreign buyers jacking up prices and unaffordability taking over major cities. Investor speculation and short-term rentals are the main culprits behind high vacancy rates in places like Toronto and Vancouver. In many other cities across the nation, decreasing populations, combined with fluctuations in local economies, are also contributing to the spike in the number of vacant homes.

In 2001, when the government first started collecting data on occupied dwellings, 7.8% of all homes in Canada were vacant. In 2006, the vacancy rate had increased to 8.4%; by 2016, it had reached 8.7%.

More than 66,000 homes are sitting empty in Toronto, ON and around 64,000 vacant homes are spread across Montréal, QC while Calgary, AB Ottawa, ON and Edmonton, AB all have more than 20,000 vacant properties. Of Canada’s largest cities, Vancouver, BC has the highest share of empty dwellings: its 8.2% rate translates into about 25,000 vacant homes.

For perspective, vacancy rates in the U.S. never climbed higher than 2.8%, according to the Federal Reserve Bank, while Canada’s empty homes represent a whopping 8.7% of the market, per the 2016 data.

Obviously, there are pockets where things are different.

But record low interest rates have meant that people have ploughed money into housing. This boom has fuelled immigration and created jobs. But what happens when that stops?

In Sydney in particular, more restrictions for investors has put a stop on housing demand and prices have decreased. But Sydney is still considered unaffordable even with the recent downfalls.

Plenty of people can’t afford a home. And at the end of the day that reality will hit because property has become detached from salaries and the economy.

Would housing affordability be a problem if interest rates were higher?


Selva Freigedo Signature

Selva Freigedo,
Editor, The Rum Rebellion

PS: Greg Canavan recently caught up with US gold expert Jim Rickards to talk about the truth behind the recent rise of the gold price in Australia. Click here to watch.

Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

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