The end of the global real estate boom?

Real estate is the world’s biggest single asset class. Typically, property accounts for two-thirds of the tangible capital stock in almost every nation’s economy


And these last few years, its value has been booming. In the US alone, one-quarter of the jobs created there since 2001 have been in construction, real estate and mortgage finance. The world economy has withstood a dotcom bust, international terrorism and high oil prices. Yet many are now starting to believe that a real estate bubble has been propping up the World Economy and it’s about to burst. The trigger – they contend – could be a sharp fall in the US Housing market. This is because America is 30 percent of the world economy and its consumer spending has been part-fuelled by rising house prices.

No question, the returns in property have been unprecedented, both in the size of the gain and the spread of countries involved. In the last five years, the price of the median US home is up an inflation-adjusted 50 percent. The world’s highest return though has been in South Africa, 227 percent from 1997-2004, according to The Economist House Price Index.

The hard question is why?
In many countries, one could fairly cite a shortage of supply, cheap credit and planning restrictions. But that’s not the whole story. Real estate is being touted as an investment, appreciating faster than inflation and incomes for many years to come. This is nonsense.In many ways, real estate is a terrible asset class. It’s illiquid, it’s expensive – there are high transaction costs and it usually involves taking on very large debts. Curiously, it is nothing like as well researched as much smaller stock, bond or even forex markets by analysts or economists.

We have all also somehow being led to believe that a rise in house prices is good for the economy. It is not. When property prices rise faster than incomes – as they have done in most economies for at least a decade bar Japan and Germany – this has made people much poorer in real terms. Unlike companies that sell more products more profitably, housing stock does not intrinsically improve its output. It is merely valued on future rental income or more worryingly, anticipated capital gains – the definition of a speculative bubble.

To use the jargon, the world economy is overweight in real estate. In the UK, 59 percent of £6trn of assets is tied up in property. That’s three times the annual GDP output. Yet whilst the value of real estate is a floating market price, the cost of its underlying debt is a hard-numbers certainty. That means that the fallout from a global housing bust could be pretty spectacular.

It is at the top end of the housing market that prices have gone into the super league. In 2004, according to Forbes, there was only one home in the world priced over $100m. In 2005, there were four. There is a new class of internationally mobile wealth driving this end of the market. It started with the Russians moving into London. Many anticipate that the same will happen with China, Brazil and India.

So how long can the property market keep booming?
America is key and it is cooling off fast. With the US Fed rate recently raised to 5.25 percent, the days of cheap money are over. Consumer spending – part financed by mortgage equity withdrawals – has been outpacing income and this is not sustainable. Economic historians will tell you that housing booms always precede recessions. Another factor is the rise of the teleworker, already millions strong, made possible by broadband internet connections. 10 more years of improving bandwidth just might truly internationalise the global workforce and signal the end of the high density and expensive commercial city centre rents. Anyone who thinks a property bust (a fall of more than 30 percent) following a boom will not happen need only look at Japan. From 1991-2005, Japanese property prices dropped for 14 years in a row, by 40 percent.

So any retiring Western couple intent on selling their home and moving abroad to the sun should try something else. Rent out your home, rent more cheaply abroad and live off the difference. Your assets – property, stocks or otherwise – should perform for you, not the other way round.

Dan Lewis is Research Director of the Economic Research Council