Housing, the ultimate momentum trade

June 25, 2014

What will happen next in the housing market? The question comes up all the time in many countries, for an obvious reason: house prices jump around too fast for the good of the economy.

The price hyperactivity does not follow a uniform pattern around the world. Look at the indices of average prices for dwellings by nation, adjusted for inflation, compiled by the Bank for International Settlements. Since 2000, the real average price is up by 63 percent in the UK, by 49 percent in Switzerland and by 12 percent in the United States. The average Dutch price declined by 7 percent. In Germany, though, there has been so little house price action that BIS could only find data back to 2003. Since then, the average German price is down by a tiny 1 percent in real terms.

Basic economic indicators – GDP growth, employment levels and general price levels – can explain almost none of this variation. The patterns in the American and European economies over the last 13 years have been far more similar than the house price trends.

Concrete variations in the balance of housing supply and demand are more relevant, but more for differences within than between countries. Variations in planning rules and demographic patterns have been nowhere near large enough to explain the sharply different direction of house prices.

Finance is more relevant. The amount that people actually pay for housing is closely related to how much money they can get their hands on. That sum is strongly influenced by such financial factors as monetary policy, lending practices and tax rules. These have moved much more than anything in the real economy. For example, tax changes explain much of the Dutch house price fall.

However, financial conditions in developed economies were also fairly uniform from 2000 to the present. Monetary policies were generous and lenders shifted from enthusiasm to caution after the crisis. The main cause of the housing price differences is not supply and demand and it is not finance. It is something more distinctly local: house price psychology.

The current price of housing is largely determined by potential buyers’ answers to questions which are more mental than objective. How much do you care about house prices? What do you think the future price will be? How much of your income will you dedicate to housing? How much of a chance will you take on the dwelling’s future value?

Of course, finance and psychology are intertwined. Lenders will dole out more money as house prices rise, and cheap and large mortgages encourage buyers to bid up prices.

Economists capture the financial-psychological portion of housing prices by dividing the house price into two parts: the cost of constructing a new house of the same quality and the rest. The residual over the imputed construction cost is assigned to the land which comes with the residence.

This land value varies dramatically. The Lincoln Institute of Land Policy and the Wisconsin School of Business have compiled historical data on 46 American metropolitan areas. Their work shows the proportion of the purchase price attributed to land has ranged from 5 percent in Atlanta in 2001 to 89 percent in San Francisco in 2005. In Dallas, the proportion ranged between 13 and 62 percent since 1996.

Anyone who has listened to, or participated in, the fevered discussions of property values during a housing boom can recognise what is going on. In good times, land – the value of housing as a financial asset – looks like a pot of gold in easy reach. Just buy now and cash in later. And anyone who has seen, or felt, the pressure of falling house prices, will know how much panic can be sown by the discovery that the pot is empty.

Gyrations of greed and fear are certainly not exclusive to the housing market. Indeed, all finance is cursed by the perennial return of the false belief that some sort of investment – in tulips, shares, copper futures or houses – can provide great wealth without any serious economic work. The mistake leads to ludicrous prices, ugly behaviour, wasted effort and – when the money runs out, as it always does eventually – to disruptive price crashes.

Land speculation, like any other type of greedy behaviour, is a perpetual temptation. However, cycles of housing bubbles and crashes are not inevitable. Economic discipline can restrain psychological excess.

In practical terms, that means introducing a much less permissive approach to housing finance. The regulation of lenders should aim specifically at moderating price moves – for example, loan-to-value curbs triggered by soaraway annual house price gains. To hammer home the point, the taxes on real capital gains from property should be punitive for existing stock.

Technically, the required changes would be relatively straightforward. Politically, though, they need to overcome a serious obstacle: too many people care too much about where house prices are heading.


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You hit the nail on the head, Mr.Hadas. Greed coupled with market manipulation by BIG investors is what causes the ups and downs. Blackstone Group, one of the largest hedge funds in the world and squarely behind the bad housing paper that caused the global meltdown, is now buying up foreclosures by the tens of thousands throughout America, probably for pennies on the dollar from the BIG banks that foreclosed and kicked people out of their homes, and renting them at exorbitant prices which is causing yet another affordable housing crisis in cities like Seattle. We must get investment manipulation and speculation out of OUR real estate market and prevent investors from outside America from buying up OUR land.

Posted by njglea | Report as abusive

A house is also different from any other investment – it has an emotional grip on its owner which distorts logic. How many people do you hear say “this is my house”, if you try and correct them and say, “well actually, the bank owns most of it” they act as if you are talking nonsense.

Posted by BidnisMan | Report as abusive

Most people are simply not well suited to making investment decisions, no matter how good they are at their day job. Take the largest number of unsophisticated participants and massive leverage, combine that with the relatively large amounts of money involved, and you have the housing market. I am not sure what you can do about that other than making sure lenders retain responsibility for their own bad loans. Some other cures, such as Mr. Hadas’s “punitive” taxes are likely just to make things worse.

Posted by QuietThinker | Report as abusive

For a home owner (owner occupied) it is not an investment. At best it lowers cost of living once paid off and my offer some money when you retire thru sale or reverse mortgage.
For small real estate investors, single family homes rarely make sense as they are to costly to maintain and difficult to keep leased. Duplexes and larger are much wiser investments.
After the crash, so may single family homes became available at dirt cheap prices that many larger investors just couldn’t resist. On paper they look so good. I think that many will find that they are not making what they thought they would and begin to sell them back to owners in another few years.
Overall, I think the US should move away from single family and duplexes. Multi-family dwellings; apartments, condo’s, etc.. are a much better use of resources. Besides, the American dream died with the 20th century.

Posted by tmc | Report as abusive

“the taxes on real capital gains from property should be punitive for existing stock”

Generally a good article; but punitive taxes aren’t a workable solution for price increases in residential housing. Taxing unrealized capital gains before a house is sold would create a huge unknown financial burden for those who are not responsible for house price increases. People buy houses to stabilize their outlays – this would introduce a big variable. Should someone who has been living in the same house for 25 years paying off their mortgage now have to face a huge penalty when they sell that house and then not have enough money left over to buy a similar house elsewhere – a house which would also have had an equivalent increase in price? Tax policies which penalize moving mean that people cannot rightsize their housing or move to better jobs, retirement locations, etc.

Posted by walstir | Report as abusive