Tom Stevenson looks at current events in major housing markets around the world and suggests investors consider five key factors.
Following the extended residential property boom that lasted until 2007-8, many of the world’s housing markets have since undergone a synchronised downturn.
The size of the correction has varied from country to country, with significant housing recessions in some countries and strength in others – as shown below.
What’s next for these markets?
First, it is less appropriate to talk of the ‘global housing market’ in a collective way. Housing markets have become increasingly local, with correlations dropping sharply.
House prices in Hong Kong (the top-performing country) were 24.2 per cent higher than a year earlier in the first quarter of 2011.
In contrast, prices in Ireland – among the worst performers – were 11.9 per cent lower in the same period.
Housing markets matter to all investors
Where there is a culture of home ownership, residential property tends to account for a relatively large share of national wealth.
The US and UK are good examples of this.
Higher property prices (even if they are unrealised through sales) tend to make people feel wealthier, causing them to spend more.
Secondly, higher property prices can boost consumer spending more directly because they allow people to borrow money against the increase in the value of their homes.
Property markets can also affect fixed investment spending because higher prices tend to encourage greater construction activity.
When house prices fall, as they did during the crisis, then the effects on both private consumption and fixed investment will be negative.
What’s happening in the US housing market today?
The significance of the US housing market is underscored by the fact that it effectively originated the global financial crisis via its sub-prime sector – aided, of course, by very loose credit and exacerbated by financial engineering.
Given this history, it is reasonable to think that a clear recovery in the US housing market could have a significant positive bearing not only on the US economy, but also the global economy.
The US housing market has experienced a continued recession. According to the Case-Shiller 20-city home price index, as of April 2011 prices were almost a third lower (32.8 per cent) than the July 2006 peak; moreover, the latest reading is less than a percentage point away from the April 2009 low-point, suggesting the risk of a possible double-dip in prices.
While US gross domestic point (GDP) growth has bounced back, unemployment has remained elevated, so the cyclical backdrop is neutral at best. In addition, the supply situation is particularly unfavourable owing to the large number of foreclosed properties.
However, the negatives in the US housing market today are counterbalanced by two key positives. From a valuation perspective, the sharp correction in prices has made housing much more affordable.
In addition, since most US mortgage loans are linked to the 10-year US Treasury yield – which is near record low levels – mortgage/income ratios are also very favourable at present. On balance, while it is possible that US house prices may have a little further to fall, the chances of further big declines from current levels are fairly limited.
The economic importance of the US housing market means that serious downside risk would be mitigated by additional policy stimulus.
On the other hand, if the cyclical position of the US economy improves and unemployment comes down further, then conditions could become ripe for a recovery in the US housing market.
This would have positive second-order effects on consumer confidence and provide a more supportive environment for equities.
Where’s China’s housing market heading?
Apart from the US, the only other country in which the residential housing market can be seen as having a high degree of global significance is China.
Indicative of the rapid changes taking place in China, it was not until 1998, when the Chinese Government decided to privatise the country’s urban residential housing stock, that most ordinary people were able to acquire their own homes for the first time.
Today, official figures (which need to be treated with caution) claim that home ownership in the country is as high as 89 per cent.
Irrespective of the precise numbers, it is clear that China’s residential sector has seen a remarkable boom in terms of ownership, investment and prices.
Partly the property boom there has reflected the fact there are relatively few other viable investment alternatives for most ordinary Chinese.
Less well appreciated, though, may be the linkage between commodity prices and China’s housing sector.
For example, construction directly accounts for about 40 per cent of all Chinese steel usage, but when home appliances, property-related infrastructure and other property-dependent sectors are included, this figure jumps further to a remarkable two thirds.
Massive investment in construction and a relentless rise in property prices have raised concerns that the sector may be at risk of overheating, with ultimately negative effects for China and the global economy.
In response, the Chinese government has introduced a range of measures aimed at slowing speculative demand (especially in the luxury segment) and stimulating overall supply (especially in affordable segments). Affordability is now clearly stretched by most measures.
Fortunately, policy measures aimed at cooling the property market, and inflation generally, appear to be having some impact. The concern, however, is that instead of slowing, prices may begin to collapse.
However, a number of factors should help to mitigate the risk of a severe collapse. Firstly, if the risk of collapse became more real, the authorities would likely take countervailing measures.
Secondly, while prices appear somewhat elevated at the present time, it is worth remembering that urbanisation is increasing rapidly in China, coupled with continued strong income growth, risks over the medium to longer term should be lower on account of this.
Finally, a critical factor is that unlike in more advanced countries, the use of mortgage financing in Chinese property transactions is minimal.
The lack of leverage means that, even in the event of a property market collapse, there would be fewer of the cascading negative effects we would expect to see in more highly-leveraged western markets, in terms, for example, of foreclosures, bank write-downs and associated credit tightening.
When looking at today’s housing markets, we suggest investors consider five key factors:
- Cyclical position – as measured by real GDP growth and especially labour market conditions (ie, real income growth and unemployment).
- Valuation – as measured by affordability ratios such as average price-to-average income and return measures such as annual rental income-to-price (ie, yield).
- Mortgage/income ratio – the relative costliness of mortgages. Mortgage costs depend largely on the level of interest rates which makes this factor particularly crucial, especially in high-leverage markets.
- Excess supply risk – as measured by the supply of new homes being constructed and property becoming available through foreclosures.
- Country specific factors – many countries are subject to more individual characteristics.
Investors have to be far more selective in their analysis and investment in markets.
Tom Stevenson is the investment director at Fidelity.
