There’s another important difference about housing investments; leverage is cheap and easy to come by. This means gains will be impressive compared to stocks; with an 80% mortgage, a 20% increase in price turns into a 100% return for you. But it also means that the potential downsides can be too easily ignored. Housing crashes are disastrous on the rare occasions when they occur because they cause leveraged losses for people who cannot afford them. With debt, a “crash” doesn’t need to be so bad in price terms to have a severe effect.
London house prices, for all their meteoric rise, have also had long periods when buyers could only sell for a loss — and having taken out massive mortgages, they were often in negative equity and couldn’t sell at all. For much of the 1990s, people with growing families found themselves trapped in rabbit hutch-like London flats they had bought straight out of college to “get on the housing ladder.” At times like this, fear of missing out can lead to lives going seriously awry:
To this we can add the political folly that elected representatives desperately want this not to happen, so they prime the market with subsidies and tax breaks. In Britain, at least, house prices are seldom allowed to fall much. That helps homeowners, but takes property ever further from the grasp of the younger generation, fomenting anger. And that leads an intelligent young man to regard housing as the ultimate safe investment. In Britain’s economy, which has been rigged to help homeowners more than the capitalists who run companies, it’s an understandable belief. But real estate can be dangerous.
I’m going to get to the U.S., which has new house price data out, but next we head to continental Europe.
Europe’s Housing Imbalances
Britain has suffered much pain thanks to housing downturns. But perhaps the most calamitous outcome to an over-extended market has come in the euro zone. This is what has happened to house prices in Spain:
A boom so distended, followed by such a long bust, must have many causes. But it’s worth focusing on the effects of the euro’s adoption, beginning in 1999. The great monetary experiment started with Spain’s economy already running hot, while Germany was still struggling to swallow reunification a decade earlier. With only one monetary policy, the new European Central Bank chose rates appropriate for Germany, the larger economy, which meant borrowing costs that were far too low for Spain. Investment funds flowed in from Germany and elsewhere in Europe, inflating an unsustainable Spanish construction boom. Then came the crash, Spain’s financial institutions were left nursing loans with no chances of being repaid, and the euro-zone sovereign debt crisis soon went into full swing, extending the European leg of the financial crisis for many years. This is how Spanish and German house prices have compared:
It is only recently that German house prices have at last overtaken those of Spain. Property busts, when they happen, can cause deep and lasting damage.
U.S. House Prices
That brings us to property prices in the U.S. S&P Case-Shiller data came out Tuesday, and showed a continuing sharp increase. Across 10 large cities, and on a national level, prices are now well above their peak before the global financial crisis. The FHFA home price index is up 15.7% from a year earlier, the highest rate on record. Whichever way we look at it, the market looks hot:
