Be Wary of Anything approaching 140% of GDP

Sunday, March 06, 2005 | 06:35 PM

I have taken the position that Real Estate is not a bubble, but is merely a somewhat extended asset class, driven that way via easy Al and his half-century low interest rates.

That means if (or rather, when) rates return to normal, a 30% give back in value is hardly unthinkable.

If a significant percentage of homes (i.e., %80+) remain owner-occupied, then the downside is more limited. Yes, 30% is quite a haircut, but not when compared to the 78% shellacking the Nasdaq took.

In terms of percentage of speculation, compare Real Estate with late '90s stock speculation. My wild guess is that well over half of the owners of, Amazon and Yahoo! were mere speculators. I would be surprised if in excess of 20% of recent home sales went to specs.

But since this site is about provoking thought and discussion, let's consider what 



Alan Ableson

Merrill Lynch's estimable economist (yes, Virginia, there are such things) David Rosenberg. What they show is a) on the left, the stock market's total value as a percentage of GDP; and b), on the right, household real-estate holdings as a percentage of GDP.

In our rendering, as you can readily see, the peak of nearly 140% of GDP was reached by the equity market in the early months of 2000. That, as you can also readily see, happens to be where the current ratio of housing (aka household real-estate assets) is now, after an extended and almost vertical ascent.

As David observes, a good rule-of-thumb is "to be wary when anything begins to approach or exceed 140% of GDP." (We assume that includes the New York Yankees' payroll.) He ticks off the various arguments bulls cite as explanation for the great surge in housing and house prices (the latter, incidentally, rose a tidy 11% last year), such as low interest rates, the availability of credit, demographic pressures, a rising tide of immigration -- but remains skeptical.

He points out that "much of the move in real-estate valuation has not been due to income generation, per se, but rather due to loose financial-market conditions and an increasing level of exuberance."

He confesses that he gets "nervous when we see things move parabolically north because no asset class at any time every failed to mean-revert after such an upside move." And, while acknowledging he has been bearish on housing for a spell now, points out that just because a bubble "hasn't burst doesn't mean it doesn't exist."

Warns David, "bubbles and baths usually go together." And so, we might add, do burst bubbles and tears.

UPDATE:  MARCH 6, 2005 11:23PM
Interesting chart from the Economist, which notes  that "According to our latest house-price indicators, it is now much cheaper to rent than to buy a house in many countries."



"According to calculations by The Economist (with the help of Julian Callow of Barclays Capital), house prices are at record levels in relation to rents (ie, yields are at record lows) in America, Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. America's ratio of prices to rents is 32% above its average level during 1975-2000. By the same gauge, property is “overvalued” by 60% or more in Britain, Australia and Spain, and by 46% in France (see chart).

The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier. To bring the ratio of prices to rents back to equilibrium, either rents must rise sharply or prices must fall. Yet central banks cannot allow rents to surge as this would feed into inflation. Rents directly or indirectly account for 29% of America's consumer-price index, so rising inflation would force the Fed to raise interest rates more swiftly, which could trigger a fall in house prices. Alternatively, if rents continue to rise at their current annual pace of 2.5%, house prices would need to remain flat for over ten years to bring America's ratio of house prices to rents back to its long-term norm. There is a clear risk prices might fall."


Tip Of The Camel'S Hump?
Alan Abelson
Up and Down Wall Street   
Barron’s, Monday, March 7, 2005

Still want to buy?
Economist print edition, Mar 3rd 2005

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» American Heresy: "Maybe I Should Rent" from 3martini
Is renting throwing your money away? Not anymore. [Read More]

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But is the ratio of rental income to home value completely linear? For instance, how much demand is there to rent a $500k home verus to own one? If memory serves, of the top 10% of the population by income, only 3-5% rent versus 30-50% in the bottom 40%. Data on price inflation by market segment might help to tease out the true underlying risk.

Posted by: mwmike | Mar 7, 2005 5:16:40 PM

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