The Global House Price BoomThe Global House Price Boom was the title for one of the September 2004 essays contained in the IMF World Economic Outlook . At the time of release, bits were reported in the press. But in the last few days of October, I was given a copy of the full report. (Don't ask where I get this stuff from, but if you happen to receive lots of good quality economic reports, I'm always keen to have a read of them. Drop me a line - I'll be very grateful.) The following points are what seemed to me to be the most useful to see and note. The report looked into the returns and volatility of returns in a number of housing markets in industrialised nations. Of those nations, the most relevant to most of my readers will be the UK, Spain, Ireland, France and Belgium. The report had a number of findings which, although you probably realise on some level, it is nice to have confirmed by economists at the IMF. Here are the highlights: Real house prices are PRO cyclical. This means that they rise in a boom and fall in a recession. There is no current link (or correlation of returns) between housing and the stock market. House prices are highly linked between different industrialised nations. This means that downturns are likely to be linked globally. Domestic interest rates play a key role in explaining house price movements. Volatility in house prices and housing markets lowers as the percentage of mortgages that are arranged as a fixed rate increases. Interesting stuff huh? The bit about fixed rates is really very interesting. The report believes that only 2% of householders in the UK take a long term fixed rate mortgage when a 'substantial portion' should be finding them attractive. It also suggests that households are not well informed about their decisions and much advice is from lenders whose interests may not be aligned with the interests of borrowers. Speaking from experience, I can see what they mean. I used to arrange very few long term fixed rate (by long term, I mean either 5 or 7 years) mortgage deals. This was largely because clients were put off by the penalties charged by lenders to repay the mortgage or overpay lump sums. Or, that they just didn't like being 'tied in'. I used to find this strange. The number of people that would avoid a mortgage with a penalty 'in case they could repay some of it' but had no clue where this potential lump of money would come from would amaze you. I think, deep down, they all believed that they would be winning the lottery soon. And yet, could we all take a lesson from the statement? After all, if volatility in the housing market can be lowered by more people choosing fixed rate and longer term fixed rate deals, could it have the same effect to individual transactions? Volatility is the amount of variation between (in this case annual) investment returns. Investment returns would constitute both the purchase price and sale price. Since we are talking about housing, the purchase price must also include the monthly mortgage repayments. Just thinking in terms of the purchase price to the seller is only half of the story. Therefore, to be able to understand the likely total cost of a property, a fixed rate mortgage must be a huge assisting factor. And, to understand the potential total and annual returns, understanding the total cost is key. Remember, when you buy a property, however you fund it, somehow, you will be paying for any wrong judgements made about interest rates. Even if you buy a property and immediately let it to tennants, guessing the direction of rates wrongly will impact you (even if only through lower profits). Of course, the real killer decision would be if you were supporting more than one mortgage yourself (perhaps via a holiday home, for example) and took multiple variable rate mortgages, only to see rates go against you. Ouch! So, to the important issue. Where to invest? The report looked at annual rates of growth and volatility between 1971 and 2003 in 18 different national markets. They also looked more specifically at 1986 to 2003. Spain showed very high rates of growth but with very high volatility too. One would presume that the huge influx of Brits to Spain has helped dramatically to increase demand whilst supply took time to catch up. The UK had high rates of growth and volatility. The property crash of the early 1990's would be the casue of this volatility in the market. As we know, supply and demand is nowhere near matched in the UK. Ireland had very high growth but with much lower volatility. In other words, prices have been rising steadily for quite some time. Belgium had growth rates above average but the lowest volatility on the scale! One can only presume that the lack of speculation in the Belgian market because of the high up front property taxes and costs (and the use of very long term fixed rate mortgages - 25 year fixed rates are not uncommon) has provided stability. The French market seems to have fared somewhere in the middle. Modest growth and modest price volatility too. With annual growth (1986 to 2003) of just under three percent it wasn't a stellar performer (lower growth than all of those listed above) but looks to have been more reliable than most nations. Of course, such reports are only a guide to the past. The only area which seemed to have any hint of the future in the report related to the UK. The sentence latched onto by the media in the UK was this, 'There is a danger that higher interest rates could trigger a much larger downward adjustment in house prices, with considerably more severe consequences for real activity'. You have heard it now from both the IMF and the Governor of the Bank of England. If you are planning to buy soon in the UK, tread very carefully. * This was published in December 2004 * To read more investment related articles, please also visit:
Recommended: Find A Stockbroker | Learn To Trade | Investing Beginner Other Sites: Investment-For-Beginners | Stock Market | Financial Blog |