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Weekend reading: House prices still over-valued

Weekend reading

My regular roundup of the week’s best reads.

The US blogger Barry Ritholtz says US houses are still significantly over-valued. That would be bad news for everyone, given that the US consumer is vital for a global recovery.

Unlike in the UK, house prices in the US did actually go pop a few years ago. They stayed down, too. And not just in the sub-prime bayous and inner-cities, either, but across the board.

In fact, I’ve wondered if I’d be tempted to buy a US investment property were £1 pound still worth $2, as opposed to the $1.50 it currently gets you.

According to Ritholtz, buying now would be a big mistake:

Today, residential real estate confronts numerous headwinds: Credit, once given to anyone who could fog a mirror, is now tight. Hence, demand is far below what it was during the past decade. Home prices are still unwinding from artificially high levels, and remained over-priced. Inventory is elevated. Unemployment remains high. A huge supply of shadow inventory is out there: Speculators and flippers who overpaid but have held onto their properties await modestly higher prices to sell. Bank owned real estate (REOs) continues to increase. We are barely halfway through a decade long foreclosure surge.

This is known, or at least should be by those who have looked at the data. I cannot explain why some economists still have not figured this out.

In my analysis, price stands out as being the prime mover of the next leg down. High unemployment, and a decade of flat wages aren’t helping to create any new housing demand. And the millions in homes they cannot afford will eventually add more pressure to inventory and prices.

It’s prices-to-rents that I nowadays find most interesting. (The alternative, price-to-earnings, has been trending higher for decades, after all).

Ritholtz offers the following graph:

Click to enlarge

While this graph does suggest house prices still have a little way to fall, what strikes a UK reader is the magnitude of the correction that’s already taken place.

Here in Britain house prices have already partly bounced back, with Santander this week reporting that there are still five times as many property millionaires as a decade ago:

While the credit crunch led to over 43,000 homes losing value and falling below £1m between 2008 and 2009, the statistics now show a recovery in the market for million pound properties.

Over the past year alone, the number of properties valued at £1m or more rose by around 29,000, boosting the number of property millionaires – the owners of these properties – close to the early 2008 peak when there were 147,000 of them.

Having barely wobbled and rebounded in London, UK house prices remain significantly elevated according to The Economist. Using the same price-to-rent analysis as Ritholtz applies to US home values, it said in April that UK house prices are 30% over-valued.

The snag? A price-to-rent analysis has been concluding the same thing since 2004, as some of us know to our cost.

Unlike the bearish sentiment in the stock market, few are predicting house price falls in 2010. Ironically that might just make a correction more likely.

The best of the blogs

From the financial big boys

  • Gold: Store of value? – The Economist
  • Why are companies still so cautious? – The Economist
  • BP’s partners shirk blame [No wonder seeing how it’s been treated!]BBC
  • Pension losers in the switch from RPI to CPI – FT
  • Tax risks of offshore ETFs [Pretty much why I only use iShares]FT
  • Screening for quality dividend paying companies – FT
  • Bear market just took a breather, warns FT’s chartist – FT
  • Absolute return funds fail to live up to name [Told you]The Guardian
  • Current best savings bonds – The Telegraph
  • Advisers peddling poor investment bonds [Gasp!]The Independent
  • Grumpy old men bank in the making – Peston at the BBC
  • How to tell if you’re a successful investor – The Motley Fool

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{ 17 comments… add one }
  • 1 Thomas Jones July 10, 2010, 4:41 pm

    The UK house price conumdrum is one that baffles many, including myself.

    We certainly haven’t mirrored the US and I’m not sure if this is likely to happen with a 30% correction.

    Okay, there’s the fundamental supply/demand equation but still, how can house prices keep on rising and remain affordable in this economy?

    My take is that this marks a permanent shift towards a much larger rental market with a transfer of wealth to the landlrod (landed) classes.

    Prices will probably drop a bit more but not sure by how much.

    I do think property is overvalued in the UK and a double-digit correction could be beneficial in the long-term as saving for deposits and paying more in interest impacts the wider economy with people spending less on other things.

  • 2 Financial Samurai July 10, 2010, 5:01 pm

    Here’s one US blogger who says US housing is so UNDERVALUED based on rental yields and the current risk free rate.

    I’m buying properties as we speak, b/c the math works!

    .-= Financial Samurai on: Even Lebron Doesn’t Listen To President Obama =-.

  • 3 The Investor July 10, 2010, 6:12 pm

    @Sam – Yes, I think I’d buy US property if I was a US citizen now, especially in places like California. Just like with equities it’s pointless trying to catch the very bottom – even if Ritholtz is right, most of the carnage has surely already happened. The Economist article I link to above also agrees, saying US house prices are actually -3.7% undervalued by rent. Lies, damned lies, and statistics.

    Unfortunately house prices in the UK still live in 2006!

  • 4 The Investor July 10, 2010, 6:14 pm

    @Thomas – I agree there’s been a transfer of wealth to the landlord classes (or more generally the older generation at the expense of the young, as the Coalition MP Willets’ says in his new book The Pinch). Will it be a permanent shift? Hard to tell.

    Martin Wolf in the FT recently said he thought it was unfair, but that the only politically acceptable solution was to accept past damage and tax windfall gains in land prices from *here*. In other words, pull the ladder up behind… at least until the boomers die off.

  • 5 George July 10, 2010, 10:21 pm

    Here in Oregon (NW corner of USA), we’ve got at least another year of downward trend in housing prices, possibly as much as a 15% drop if hiring doesn’t pick up. The price of crappy rural duplexes to fourplexes are suggesting you can make 10+% by being a slumlord provided you can fill the units. These are not pretty properties and people, but… it’s an indication that rents are significantly higher compared to owning.

    Few people are selling their homes, rather it’s mostly REO property or relocations that are creating the market.

  • 6 Macs July 11, 2010, 2:47 am

    Wow… given the choice of being a slumlord at 10% or an HMV shareholder at 13% I know where my money is going… sorry, I should say ‘has gone’ 😉

    I think the big issue with the UK market is VOLUME. So few properties on the market keeps these ‘paper millionaires’ feeling smug. It doesn’t and *never has* meant anything what any asset is ‘worth’ on paper. It only ever has one value, and that is what someone gives you for it at the TIME YOU SELL. If you don’t sell, you don’t know.

    Now I appreciate that the US market may have been different recently as witnessed by the trend for using the house ‘equity’ as an ATM. I’m sure some over this side of the pond did it too… but not to the same extent. I guess I’ve been a bit old fashioned like that, I only ever reckoned on my house being worth ONE HOUSE. Nothing more, nothing less, whatever the chatterati in the Sunday supplements might tell me. Isn’t it obvious? If my house goes up in value, so do all the others – if I sell this one, I need to buy another, which has gone up the same amount. So there CAN BE no profit in property prices rising, unless you’re selling up to go homeless…

    With tightening credit raising the bar for first-timers then I think (hope) that prices come down. WHAT???!!! A property owner wishing for declining prices? Yes… as I said, my house is STILL worth one house, even if the price crashes. I think it comes back to price vs value once again….


  • 7 ermine July 11, 2010, 9:38 am

    I was amazed when I was in the States near Long Lake just how cheap house prices were, and you get a lot of house and land for your money 🙂

    Something to watch for, however, is that from what I read on US PF bloggers’ sites property taxes in the US seem very high compared to even our Council tax.

    In the UK prices will fall when interest rates go up and more people lose their jobs from the cutbacks, like they did in the 1990s. London may still be an anomaly however 🙁
    .-= ermine on: ConDems to Final Salary Pensioners- All Your Base Are Belong To Us =-.

  • 8 The Investor July 11, 2010, 11:27 am

    @ermine – Yes, I have far-flung relatives across the world, too and I often wonder what I’m doing here. 😉

    I’m not convinced unemployment will rise massively from here, though I’d certainly agree it’s not coming down in a hurry. Agree about interest rates though. I think they’ll rise slowly enough to ward off a crash, but that prices are pretty much capped for the foreseeable – even in London if the pound appreciates further.

    Surprised by your “All you Base” reference. Not you demographic?! 😉

  • 9 The Investor July 11, 2010, 11:29 am

    @Macs – Yes, somewhere along the line the home became an investment, rightly or wrongly. Probably after the baby boomers saw their parents quadrupling their money (or more) and thought I’ll have some of that.

    Regarding using homes as an ATM, I’m afraid to say the same thing did happen in the UK. At the height, so-called MEW (Mortgage Equity Withdrawal) was responsible for something like £1 in every £7 spent by consumers in the economy. (Gulp!)

  • 10 The Investor July 11, 2010, 11:32 am

    @George – Yes, from everything I’ve read it looks like you eventually saw the sort of forced sale conditions in the US that I thought would eventually make it affordable to re-enter the UK housing market, too. But we never did see such conditions here, and so I think it’s still too risky.

    Personally I’d risk 10% downside for the right house, but not the 30-40% that still seems possible here if interest rates returned to north of 5%.

  • 11 George July 11, 2010, 11:33 pm

    I was stumbling around on the internet and tripped over this lovely piece of trivia concerning the wealthy in the USA and where they hold their assets: http://www.census.gov/compendia/statab/2010/tables/10s0703.pdf

    What it shows is that the wealthy hold more of their wealth in stocks/bonds/conventional financial assets than they do in real estate. States that have overpriced real estate (e.g. California and Hawaii) are closer to 1:1 than other states (Oregon is about 4:1).

    Conjecture as to what this shows:
    1) the wealthy do not make their wealth in real estate, but when real estate holdings go up in value, they do not dispose of them.
    2) the wealthy do not purchase properties that exceed their net worth
    3) the wealthy mortgage their properties to the hilt, but back that up with other assets

    Yes, conjectures 2) and 3) are probably contradictory. If 3) is true, then the cheap leverage is used in real assets, but that goes counter to the California and Hawaii statistics. If 2) is true, then the average homeowner is very foolish (which I can well believe or else they wouldn’t still be average).

  • 12 The Investor July 12, 2010, 1:30 am

    Conjecture 4) They had more of their net worth in real estate, but then the US house price crash halved its value! 😉

    More seriously, this is an interesting spot. I wonder (without yet looking at the data) if it’s partly because the really rich own real estate through their own holding companies, which may show up in the data as a company, not as a direct property investment?

    I do know the US wealthy are much more interested in equities than the UK lot, where property is absolutely the thing. If someone makes money in the UK, the upmarket estate agents can’t drive them out to Berkshire or the Cotswolds fast enough.

  • 13 George July 12, 2010, 5:18 am

    Dang, just noticed that the pdf file from this study didn’t have the same data as the spreadsheet: http://www.census.gov/compendia/statab/2010/tables/10s0703.xls

    Though this was published in 2010, the data is from 2004, so the real estate crash is still in the future.

  • 14 The Investor July 12, 2010, 8:46 am

    Thanks George. The US has just done a new census, I recall – I wonder when the data will be released?

  • 15 Ade July 27, 2010, 2:44 pm

    Yes, there is a supply issue in the UK in part keeping house prices artificialy high. Builders realised they were onto a good thing. Why build twice as many at half the sale price when you can limit builds and keep an inflated selling price.

    House price rises are applied as a skew and do not reflect the volumes or types of properties being sold. A few larger properties sold tend to increase the average sale value when averaged across all of the properties sold. A reduction in sales of lower value properties leads to an apparent increase in the average sale price. Higher valued properties will always change hands as there will always be a group of buyers above a band which are not particularly affected by a double figure over inflation of prices.

    In the UK market there is also the issue that due to the increased value of property people simply borrowed against that asset to make the property larger. This in turn increases the average property value without selling and makes it far less likely for the owner to move any time soon. The property market has become a pyramid scheme in the uk with people borrowing on the promise of an ever increasing asset value and so the risk has been shrouded. Ironically, whilst keeping inflation levels low for general purchases, the house price/borrowing boom has been inflation on overload and for some bizare reason it was allowed to happen. I’m not sure how giving the banking system billions will enchourage people to borrow further above their means, although one might assume that the glut of borrowing across the economy must outweigh such consideration and for someone it made perfect sense, or perhaps was the lesser of two evils. Giving the banks lots of money would be like buying stock for a clothes store which is running at a loss just to keep it open a little longer.

    One has to ask the question “why was this allowed to happen?” rather how.

  • 16 joe April 1, 2011, 12:34 am

    Undervalued here in the US??? What are you smoking and good luck with your 15% loss.

  • 17 The Investor April 1, 2011, 7:28 am

    @Joe — Prices in the US may well keep falling for a bit, as crashes often overshoot for emotional reasons. But looking at long term valuation metrics (and accepting there will be state by state variations) I do think US house prices are roughly back in line.

    It’s no better to be greedy at the bottom than it is at the top.

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