Is the New York (indeed, the US) housing bubble going to burst? A look at the
situation in the UK would suggest that it isn’t. Interest rates have already
there – but a new
report says that 25 or 50 basis points here or there is going to make no
difference, and that rates will have to double before the mania is
What’s going on? The average UK house price is now increasing
at a rate of £1,100 a week: that’s $2,000, near enough. Capital
gains on housing are generally tax-free, which means that a worker would have
to be earning a six-figure salary – in pounds
sterling – just to match the amount that the average homeowner is
making from just sitting in their property as it appreciates.
It’s worth remembering, too, that all these numbers are UK averages: insert
whatever insane multiplier you like to get the equivalent numbers for London.
But to take Tony Blair’s old
house as an example, the PM sold in 1997, when he moved to Downing Street,
for £615,000; it’s now back on the market, listed at £1.69 million.
In other words, if he’d retired instead of becoming prime minister, he’d've
made £1.08 million – just under $2 million – from owning a
six-bedroom in Islington. That’s more than he’s made as PM.
The bubble is being driven, it would seem, by people known in the UK as "buy-to-let
investors" – basically, individuals who buy houses not in order to
live in them, but rather to rent them out. Historically, this market has behaved
rather like a bond market: given a set rental income and a set mortgage rate,
it’s easy to calculate how much a house should be worth. More recently, however,
buy-to-let investors have been behaving more like equity investors, who treat
rental income more like a welcome stock dividend than as the main reason for
buying the asset in the first place.
Whenever there’s a housing bubble, prices always rise faster than rents. We’re
seeing that in New York: it’s been a long time since you could cover mortgage
and maintenance costs by renting a place out. The UK is the same way, but the
buyers don’t care: even if they have to pay some of the mortgage costs themselves,
they’re making so much money in capital appreciation that it doesn’t matter.
This kind of thing isn’t really happening in the US to nearly the same extent.
The housing market is something touted in late-night get-rich-quick schemes
on the television, not a respectable way to build a nest egg. But consider a
student who’s just graduating from NYU. If that student, or her parents, had
bought a place four years ago and sold it now, there’s a good chance that the
profit could cover not only the mortgage and maintenance costs, but tuition
fees as well. If you start off rich enough, it would seem, you can essentially
go to college in New York for nothing these days.
Just like any other asset bubble, the longer this kind of unsustainable situation
goes on, the more people pile in, trying to get rich quick. It’s easy: buy a
$1 million apartment today, with $100,000 down and a 90% mortgage at 6%. Watch
it go up by 75% in two years, and sell it for $1.75 million in two years’ time.
You’ve spent $108,000 on mortgage costs, say another $24,000 in maintenance
costs, and a bunch more in legal fees – say $150,000 all in all. Your
total investment: $250,000, including down-payment and costs. Your total return:
$1.75 million minus $900,000 in mortgage equals $850,000. Net profit: $600,000,
or $300,000 a year: call it $25,000 a month. Oh, and you spent nothing on rent
the entire time. Sound attractive?
Of course, you’d make even more if the mortgage were smaller and you paid more
of the upfront cost in cash. So you take your $600,000 and use it as the down
payment on somewhere else – and so the cycle continues. Even if you allow
yourself $100,000 a year for living expenses, you can rapidly make millions
by flipping properties in a bubble economy.
This sort of behaviour is quite common in the UK; it’s barely even beginning
here in the US. Very few Americans buy property in order to become rich; most
still do it for the old-fashioned reason of needing somewhere to live. The frenzy
of apartment-buyers in Manhattan is not a slathering horde of speculators falling
over themselves to get a piece of the property-market action: rather, it’s a
bunch of stressed-out professionals desperately trying to find somewhere they
can afford to buy.
Look at those UK base rates again. They’re at 4.25%, compared to just 1% in
the US. Even if we get 325 basis points of tightening, we’ll only be at the
same place that the UK is now, and the UK’s rates are clearly well below the
level needed to decelerate house-price inflation. In other words, don’t count
on the Fed to precipitate a housing-market correction.
Sooner or later, of course, property prices will come down: they can’t keep
on running away from rental incomes indefinitely. But they’re a bit like the
US current-account deficit: unsustainable in the long term, but showing no sign
of decreasing any time soon. So long as the economy continues to expand, my
guess is that people will continue to feel comfortable putting their money into
bricks and mortar – and increasingly, they’ll be doing so as an investment.
After all, we’re four years on from the dot-com crash, and property is the only
asset class which has done very well in good years and bad.
So, what would I do in this market? Buying property is very expensive –
and, in the long term, I believe, it could prove to be extremely painful. Does
anybody remember negative
equity? Maybe the best thing to do would be to start a new blog, devoted
to the excesses of the New York property market. That should be bound to do
well. I’m not good at coming up with names, but curbed.com has a nice ring to
it. I haven’t checked it out, though: maybe someone else has got there before