Housing bubbles could be coming, and these four cities will be hit worst…

Many of the world’s leading cities are experiencing soaring property prices. Something must be done to avoid another unsustainable real estate crash

 
Hong Kong, China. The region has been plagued with allegations of corruption as to how its property market is run 
Author: Jules Gray
July 16, 2015

Owning your own home tends to be most people’s main aspiration. The security – both financial and psychological – that comes from owning a property means that it is the first thing that people look to buy when their careers start taking off. However, with a soaring global population and an increasing shift towards city living, many of the world’s working population are finding getting on the property ladder a financially unrealistic proposition.

Sky-high demand for property and not enough space to build in many of the world’s major cities is meaning many people are being priced out of the market. At the same time, property markets have become a far more stable investment that others in recent years, with real estate in cities like London proving more resilient to market changes than traditionally low risk investments like government bonds. This has in turn pushed prices up, as investors pour money into property with little intention of actually living in the properties, therefore taking homes out of the market for potential homebuyers.

Fig 1

Calm before the storm
While investors have enjoyed strong returns on their property portfolios in recent years, there are growing fears among observers that a global property bubble is getting out of hand. Were it to burst, a huge amount of money will be lost, which could in turn send shockwaves through many developed economies that are only just getting to grips with the downturn over the last seven years.

A recent report by US-based analysts MSCI showed that 2014 had been a bumper year for real estate investors, with an average rise in value of 9.9 percent. This represented the fifth consecutive year of increases and the best figure since 2007. However, while investors have increasingly seen property as a safe-haven for their money, MSCI’s Head of Real Estate Research, Peter Hobbs, warned that the strong performance might not be sustainable. This is because rental yields are hitting record lows – a sign last seen in the run-up to 2008’s crisis.

“With much of the strong recent performance being driven by falling property yields, increasing concerns are being raised over its sustainability. On the one hand, income returns – that tend to account for the largest component of real estate performance – have fallen sharply, from an annualised 7.4 percent in the UK at the end of 2009 to 5.6 percent today, and from seven percent to 5.3 percent in the US between mid-2010 and today. On the other, these yields are down to levels not seen since 2007/8, the prior cyclical peak and a powerful signal of market pricing”, writes Hobbs.

The real estate markets, like most other markets, tends to be cyclical in how it performs, with the downturns having severe consequences for the wider economy. The problem with housing market bubbles is that they tend to affect a wider proportion of the population – and therefore of GDP – than a stock market bubble (see Fig. 1). According to studies by the IMF, stock market bubbles tend to be relatively frequent and last under three years, with losses of around four percent to GDP. By contrast, property bubbles have far greater impact, even though they are less frequent. The IMF estimates that the effects linger for around seven years and cause roughly eight percent in lost GDP.

Instigating factor
The global financial crisis that began in 2007 has some roots in the bursting of a number of housing bubbles that had grown to unsustainable limits around the world during the beginning of the decade. A huge swathe of countries experienced soaring property prices, including the US, Austria, UK, Italy, Turkey, Brazil, Denmark, Portugal, China, Mexico, India, Hong Kong, Ireland and South Korea.

During the middle of the last decade, The Economist described the global rise in property prices as “the biggest bubble in history”. When the crash hit – most notably in the US subprime mortgage crisis of 2007 – homeowners were finding their mortgage’s exceeded the value of their properties, severely damaging the solvency of the banks that had lent them the money.

The consequences of the housing crash around the world – and the subsequent financial crisis it contributed to – have been well documented. In the US, almost a quarter of all residential properties were found to be in negative equity at the end of 2010, while commercial properties in the UK had sunk to around 35 percent of the value they were at the height of the bubble. However, with many countries experiencing a steady rise in prices over recent years, many observers are starting to worry that a similarly devastating burst bubble might be around the corner.

Many of the markets experiencing strong real estate growth are doing so for differing reasons, and the solutions to the problem of excessively high prices will differ as a result. Here, World Finance has looked at four major cities where there is a real danger of property prices spiralling out of control, and what solutions have been mooted.

Hong Kong

Hong Kong’s sprawling mass of skyscrapers have shot up over the last few decades, reflecting the island city’s status as Asia’s most important financial centre. However, this massive development has been mired in controversy in recent years, with some of the most prominent property developers facing charges of corruption.

Last year, Thomas Kwok, the billionaire developer responsible for many of the island’s most recognisable skyscrapers, was sent to prison for five years for bribing a senior city official. Alongside his brother Raymond, Thomas Kwok has built a real estate empire in the city through his Sun Hung Kai Properties company, which is Asia’s largest property firm and the world’s second biggest. It has built a number of luxurious towers in Hong Kong, including the city’s tallest building, the International Commerce Centre (ICC).

The fate of the property mogul brings into sharp focus the need for an overhaul of the city’s regulations. For many years, new buildings in Hong Kong have been tailored for the wealthiest people on the island, with little regard for affordable housing. As a result, the city is currently the most expensive place in the world to buy property, and a number of people have called on the government to reform the market.

Moves to increase supply in the market were announced at the start of the year, when Hong Kong Chief Executive Leung Chun-ying announced that around 14,600 new homes would be built every year until 2020, which represents almost a 30 percent increase on the previous five years worth of house building. There have also been reforms made to make it easier for people to buy and sell property. However, with protests over the last year over corruption and the cost of living, Hong Kong’s rulers will need to do more to take the heat out of the property market.

London

The sky-high cost of buying a property in London has been a consistent point of discussion among the city’s chattering classes for years now, but has only got worse recently. The reasons are varied; from an influx of foreign investors buying up the higher-end of the market and new build flats off-plan, before they even get offered to domestic buyers. Perhaps the primary reason for London’s astonishingly expensive properties is the woeful lack of investment made by successive governments in affordable housing over the last 30 years.

During the run-up to the recent general election campaign in the UK, the topic of house prices consistently ranked among the biggest issues facing voters. How to deal with these rising prices, however, proved a particularly contentious issue. The Labour Party’s proposal of a tax on higher value properties worth more than £2m – dubbed the ‘mansion tax’ – was deemed by many to be a tax on London property, and is thought to have been a major reason why it lost the election.

However, the winning Conservative Party’s plan to allow state-owned council housing and housing association-owned affordable properties to bought by occupants was met by analysts with derision, as it would do little to boost supply in the market.

What happens next in London is uncertain. The Conservative victory has offered hope to property investors that there won’t be a tax that could drive down prices. However, with such a lack of supply and continuing high demand, something drastic will need to be done to fix the affordability problem. While there will likely be much more house-building in the coming years than in previous decades, there may also be restrictions on foreign investors or the buy-to-let market. Whatever does happen, however, will do little to deter the massive desire of people to own a home in the financial capital of the world.

New York

America’s financial and cultural capital, New York has struggled to supply the levels of real estate that can match the rampant demand of buyers. With the population of the city rising four percent to 8.5 million since 2010, the city needs more houses. With a relatively tight space in which to build, prices for properties in both Manhattan and across the Hudson River soared in recent years. There have been particular concerns that the many new developments being built are more focused on the extremely wealthy, rather than providing for key workers.

Some in the industry have sounded warnings about the prospect of a bubble, saying that the recent price rises had peaked and that interest from foreign investors – mostly Russian and Chinese – had dried up. Earlier this year, Bloomberg reported a real estate agent had cut $550,000 off the value of a $7.45m four-bedroom apartment in Manhattan because of a lack of interest. Last November, leading developer Ofer Yardeni – CEO of Stonehenge Partners – told a conference that the higher end properties found on 57th Street didn’t represent value to investors: “If real estate was a publicly traded company and I could short its stock, I would very happily short 57th Street. There market there has stopped.”

Newly appointed Mayor of New York Bill de Blasio announced in April some extremely ambitious house building plans to boost supply in the city’s property market. De Blasio’s ‘One New York’ scheme will aim to build 500,000 new housing units by 2040, which far exceeds his predecessor Michael Bloomberg’s targets. While such ambitious plans should be welcomed, there are concerns that they are unrealistic and finding the necessary funding for so many new homes will prove too difficult. However, as long as New York remains such an attractive place for people to do business, there will be a need for many more homes.

Dublin

Ireland’s economy was badly hit by the global financial crisis of 2008, and it was made all the worse by the property bubble that burst the previous year. However, the country’s economy has gradually emerged much stronger in recent years. Unfortunately, a wave of property speculation has driven up prices and increased fears of another bubble in the market, especially in the capital of Dublin. Indeed, prices are said to have soared by around 25 percent over the last year, even though thousands of mortgage holders are struggling to meet their payments.

It is not just residential property that is soaring, but also commercial real estate, with companies competing for rare office space in Dublin. An editorial in The Irish Times in April sounded the warning of the increasing cost of office space in the Irish capital, largely thanks to a lack of building by the government, and the effect it could have on the country’s economic recovery:

“…with commercial rents in prime locations rising rapidly, but with little new construction under way to meet increased demand, the risk remains of a rapid escalation in commercial property prices. This would both damage national competitiveness, and threaten the pace of economic recovery – something the government, in framing the 2016 budget, should bear in mind.”

Property bubbles in Dublin are nothing new, with research showing the city has experienced a wave of property booms and busts over the last 300 years that have severely harmed the economy. Before 2007’s crash, there was a bubble that emerged during the 1990s that turned some parts of Dublin into the most expensive properties in the world. Any prospect of another burst bubble will deeply concern Ireland’s government, as well as investors who have hoped that the country’s recent economic strife was over.

  • Ian

    Don’t forget Canada.