Boom & Bust: Be fearful of 2008
In the booming property markets from Shanghai to California's Silicon Valley through the hot spots of Europe, house prices have hit record highs. The effects of the boom are spreading through economies worldwide, thanks to the feel-good factor of rising house prices has on consumer spending. But how long can it last? And what happens if it doesn't?
Fred Harrison, executive director of the Land Research Trust, believes that if history is any guide, property prices around the world will start to fall in three years' time and a global economic depression will follow in 2010 as consumer consumption collapses.
This analysis is based on a theory of the property cycle drawn from 300 years of business-cycle history and one firm conclusion: housing booms precede recessions. That said there is a big difference this time around. In the past, national economies have operated with a degree of independence. Today, the major economies of the world are synchronised into a single business cycle - and so are property prices.
In the US, house prices have doubled in the past five years, and as land becomes unaffordable to first-time buyers, builders are turning to the construction of smaller dwellings and condos. This echoes what has happened in Britain, and other hotspots around the world. In the UK alone, the value of the housing stock reached £3.3 trillion in 2004, triple the value of 10 years earlier. Real-estate prices in all the developed countries put together have risen by more than $30 trillion over the past five years, which is equivalent to 100% of their combined annual GDPs. This is greater than the 1990s stock market bubble and Wall Street's bubble of the late 1920s.
The 18-year cycle
Harrison believes that house prices can't rise indefinitely for the simple reason that at some point they become unaffordable and there will come a point when the 'average' person can't buy the 'average' house, and prices have to fall as a result. His research shows that this tends to work in 18-year cycles with 14 years of rising prices followed by four years of recession across the broader economy. This model goes for a range of economies in all continents.
Many talk about investing in "bricks and mortar", when it is in fact the plot underneath the house that holds the real value. The price of land is the best leading indicator we have of the state of health of the economy. In the boom/bust of the late 1980s and early 1990s, the price of new houses rose by 300%, but the price of land rose by 1,000%. Then both turned down, ushering in a recession that hit bottom in 1992. From 1993 until 1997, house prices stayed on an even keel. But while house prices subsequently escalated to an annual increase of 25%, the price of land rocketed, rising by 1,700% since 1979.
Just like the 1980s boom, Harrison says this will end in disaster for the wider economy, as people struggle to meet mortgage payments and cut discretionary spending. There was a 51% upturn in the repossession of homes during the first half of 2005 and Lloyds TSB reported a 21% increase in bad debts over the six months to July compared with 2004 — people are already struggling.
2008 collapse
History suggests that things will start to collapse in 2008 (18 years on from 1990 when the last bubble burst). But there are a few good reasons apart from the 18-year cycle that would indicate that the bubble will run to 2008. Government spending is still very high in the UK as Gordon Brown can raise borrowing to support his spending commitments. This should continue to offer some support to the economy until 2007/2008, when it is scheduled to tail off.
And it isn't only the residential market that will be in trouble. Speculative skyscrapers are being built as much because of their iconic appearance as for the economics of the tenanted sector, and more capital is being tied up in real estate rather than put to work in research and development. This situation is reflected Europe too.
2010 depression
Harrison says that nothing can head off the depression of 2010. If house prices are to be held at their current levels, debt levels will have to keep rising, which puts a continuing downward pressure on interest rates, which induces further upward twists in the price of houses.
In the meantime, the best thing investors can do for themselves is to move their portfolios into quickly liquidated assets. Harrison urges investors not to believe anyone who says that the effect of housing on the wider economy is marginal. It isn't, he says, it is absolutely key to the health of both the UK and the global economy.
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