Why American house prices have corrected more than those in Europe.
ANDREW MELLON, Herbert Hoover’s treasury secretary, advised the president to “liquidate real estate” as part of a plan to “purge the rottenness out of the system”.
80 years later, America has pretty much followed his advice. House prices have lost nearly all the real gains they notched up in the bubble period (see chart).
That makes for a marked contrast with Europe, where prices may be off their peaks but have not lost all their real gains. Why the difference?
Many people think that owning a house is a certain moneymaker, but this is not the historical experience. In his recent book “Safe as Houses? A Historical Analysis of Property Prices”, Neil Monnery presents data from an array of nations going back (in some cases) several centuries. What he discovers is that real house prices have generally been flat over time, or have increased by at most 1% a year. Rather like gold, then, house prices have been a good store of value rather than an automatic route to riches.
The exception is the period of the past 15 years or so, when real house prices took off in a few countries. But not everywhere. In Germany and Switzerland the trend has been flat-to-lower. In Japan there has been a decline which has pretty much wiped out the rise in house prices that occurred between 1970 and 1990. So there are really three types of market to explain: America and Japan, where real prices rose sharply then corrected; those where they rose sharply but have yet to lose all their gains; and those where the markets have been flat in real terms.
It is hard to find an explanation for price movements that applies across markets. Some cite low real interest rates as the main reason that prices have held up in Europe. But real rates have fallen sharply in America as well. For homebuyers, the best measure of the real rate is the gap between the average mortgage rate and annual wage growth. In America this is close to its lowest level in 24 years but the housing market is still flat as a chapati. Indeed, if you divide that period into three, house prices rose faster when rates were high than when they were low. In Britain, real house prices fell by a third between 1973 and 1977, even when real interest rates were sharply negative.
Just as the best way to view equities is as the discounted value of future cash flows, the best way to view property is as the discounted value of future rents. The temptation is to think that, as real rates fall, the present value of housing must rise. But why are real rates low? They are being held down by central banks which are worried about the economic outlook. If the central banks are right, then rents will surely grow more slowly in future. A paper* by Christian Hott and Terhi Jokipii calculates that on this basis, British, Irish and Spanish house prices are still well above their “fundamental” value, while those in America are about right.
Another potential explanation for America’s housing collapse relates to supply. Developers went on a building spree in places like Florida and California, and the result is a glut of empty condominiums. In contrast, Britain’s strict planning laws mean that too few houses have been built to satisfy demand. But overbuilding in Ireland or Spain reached chronic levels, too, and yet their house prices have not corrected to the same extent as those across the Atlantic.
What about demand? Houses behave more like a financial asset than a consumer good: as prices rise, demand seems to increase. In addition, there has been a trend towards smaller households (thanks to divorce, greater longevity and so on). But high house prices and tighter lending standards may have brought that process to a halt. Young people are forced to live with their parents or flat-share with contemporaries. These trends are pretty widespread, and it is hard to use them to explain national differences.
So perhaps the difference is institutional. American banks had poorer lending standards and have been quicker to foreclose on properties; borrowers have been readier to walk away from their homes. In European countries, owners have been able to sit tight in the hope that prices will recover. European markets are certainly a lot less liquid. Irish transaction volumes dropped by 83% from their peak and Spanish ones by 64%, but American deals fell by just 46%. Europe is going in the same direction as America. It is just getting there more slowly.