June 12, 2015

Recognizing Irrational Exuberance In Others

It’s Friday desk clearing time for this blogger. “Prices of real estate started their dramatic rise in or near 1997 with the decline beginning in 2006. The psychological foundation of this ’speculative bubble’ defined as price increases not based on fundamental values, was irrational exuberance, a term coined by Alan Greenspan, former chairman of the Federal Reserve. But a number of economists feel bubbles need not only irrational exuberance (following the herd and overconfidence) but also financial sources of leveraging (borrowed money to invest in assets such as housing in anticipation of large returns).”

“Personal financial gains or setbacks may be mitigated or increased by the influence of loss aversion and/or irrational exuberance. Taking an immediate loss may keep you from following a down market to the bottom. Recognizing irrational exuberance in others may point out that the end of an advancing market is near.”

“Every few weeks, a different neighborhood in New York City’s most populous borough seems to break its own record for most expensive sale. Intuitively, it feels like the borough is at a breaking point. If something goes up, must it come down? A housing expert who works for a prominent real estate investment company who asked to remain anonymous because he was speaking so candidly, pointed to Bushwick and Bedford-Stuyvesant, two neighborhoods that have traditionally been poor and lacking in amenities but have undergone rapid gentrification. There’s no rationale for paying top dollar to live in either of these neighborhoods, he said, unless you’re so desperate to live in Brooklyn that you don’t care how much it costs.”

“‘There’s a 112 premium,’ my source explained, referring to the first three numbers of Brooklyn ZIP codes. ‘It’s not like Bed-Stuy or Bushwick are good investments anymore. If you look at existing rents versus existing sales prices, you’re losing money,’ he said, pointing to listings in the neighborhoods that exceed $1 million.”

“With Dallas-Fort Worth home prices at the highest point ever, don’t be surprised if you hear more chatter about the potential for a housing bubble. North Texas home prices jumped by 14 percent in May, one of the largest year-over-year gains on record for the area. The number of sales set a record, too. Home prices in the area have shot up by more than 40 percent during the last five years. ‘I don’t know if what you are seeing now can be defined as a bubble,’ said Dr. James Gaines, an economist with the Real Estate Center of North Texas. ‘But if you have an extended period of time of double-digit price increases, you are creating a potential problem in the future.’”

“Phoenix home prices have increased this year as supply decreases coinciding with a spike in demand, according to new data released from Arizona State University. Weak supply may be because home builders aren’t building cheaper homes, said Michael Orr, who released the report. They are focusing on building homes in the $300,000 price range and up, he said. Demand has been up across all levels of homes, but supply is very weak in the $200,000 price range where homes on the market receive multiple offers, Orr said.”

“‘It’s really tricky right now and that’s trickling towards the $300,000 range,’ Orr said. ‘But once you hit the $500,000 range you’ll find a home easy.’”

“There’s a glut of empty condos in Toronto. The number of vacant completed condos in the city soared to an all-time high in May, National Bank Financial said. The absorption rate – the percentage of condos completed during the month either sold or rented – fell to 69.5 per cent. ‘It would be premature to think that the absorption rate will stay low, causing persisting accelerated increases in the number of vacant completed condos,’ National Bank Financial said.”

“Spanish home prices failed to keep up with a surge in transactions as a lingering glut of empty homes weighs on the market. The country has an estimated one million empty homes and also has the second-highest unemployment rate in the euro area at 23 percent. ‘Demand for housing continues to battle against some harsh fundamentals, characterized by households still wary of poor labor market conditions, implying the glut of unsold new properties will continue to linger,’ said Raj Badiani, an economist at IHS Global Insight in London.”

“Rents are sliding in Christchurch, as some landlords struggle to find tenants for homes. Landlord Roydon Smart recently had to drop his rents, for the several houses he owns in east Christchurch from $760 to between $550 and $650. Other landlords he knew had also lowered their rents. ‘It’s been quite a big drop. I did some market research and realised things had moved and the rents were too high. If you ask too much, people won’t look even at your property.’”

“There is growing evidence of China’s bubble bursting. After rising 26 percent a year for ten years, the value of residential property transactions in forty Chinese cities fell by 14 percent from April 2013 to August 2014. The impact has been even bigger in the major cities, with a 33 percent drop in Beijing and 21 percent in Shanghai. The number of vacant homes in China was estimated in 2014 at 49 million, double the U.S. level at the peak of the subprime mortgage crisis, according to Gan Li of Texas A&M University.”

“With 89,000 developers, China’s property industry now accounts for 15 percent of its gross domestic product and 28 percent of fixed-asset investment. ‘Across the industry, margins are falling, interest-coverage ratios are shrinking, and operating cash flow is becoming erratic,’ according to McKinsey Global Institute.”

“The central bank of New Zealand Thursday lowered interest rates even in the face of a booming property market in the nation’s largest city. South Korea followed suit, potentially encouraging gains in household debt levels that are already at a record. The Reserve Bank of Australia governor Wednesday said he may lower rates again, even as he wrung his hands over what he dubbed as ‘crazy’ Sydney house prices. Then there’s China, ground zero for the mother of all stock-market surges. The market capitalization of Chinese shares has climbed $6.5 trillion in the past year as policy makers returned to stimulus mode.”

“‘The longer these bubbles are allowed to build, the more the risks increase,’ said Gareth Leather at Capital Economics Ltd. in London, who has covered Asian economies for almost a decade. ‘It’s not just housing where there have been bubbles. Credit growth has shot up across large parts of Asia since the financial crisis.’”

“In the less exalted reaches of the US property market, where foreign investors are unlikely to stray, house prices are rising at a pace of about 7 per cent a year. Prices are on average just 10 per cent below the level they reached in 2006; if they keep going up at the current rate, they will surpass that peak sometime in 2016. In all 20 cities covered by the Standard & Poor’s Case-Shiller home price indices, prices have been accelerating. Gains of about 20 per cent are being seen in heartland cities such as Chicago, Detroit and Minneapolis, where foreign buyers are few and far between.”

‘Is this a bubble? You can look at the average ratio of house prices to earnings. It is nearly 20 per cent higher than the average level of the past 30 years, having climbed about one-third of the way from the post-crisis trough to the peak reached in 2006. Or you can look at the rental yield, which is noticeably lower than its 30-year average. This suggests that house prices are at least frothy. If you put these numbers into the context of the last cycle, house prices look about as stretched as they were in late 2004.”

“By keeping rates near zero, the Fed has strongly stimulated housing demand. It is entirely possible that this time we will see house prices go even higher. It takes many months for changes in monetary policy to have an effect, and the Fed has yet to begin tightening. By the end of 2004, the Federal Reserve was six months into a series of interest rate increases, notching up 200 basis points over the course of a year.”

“From anecdotes at the high-end of the housing market to sober evaluation of the fundamentals, it is clear that monetary policy in the US and abroad is stoking another house price bubble. To delay normalisation of interest rates is to risk repeating the mistake of the last business cycle, which was to create a house price bubble that overburdened many households. And the bigger the housing bubble gets, the greater the risk of a crash once rates are normalised.”

Bits Bucket for June 12, 2015

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