What are housing prices telling us? Assessing prices usually is complex because housing itself is complex: It fulfills an essential human need, yet also serves as an investment vehicle and a store of wealth – for many, the largest component of their wealth. What’s more, interpreting house valuations requires the context provided by credit growth, household debt levels, available financing methods, and the relationship between house prices and income growth and rental prices, among other things.
Since the sharp decline in prices during the financial crisis of 2008-09, global house prices have inched upwards, but recovery has been modest, as seen in the IMF’s Global House Price Index (see chart). It’s also been wildly uneven, with steady growth in Canada, Australia, and some Scandinavian countries, but less than healthy growth in Spain, Greece, Italy, Korea, and Eastern European countries. At the end of the second quarter, the IMF saw modest overvaluation in Canada, Israel, Norway, and Sweden, but little risk of a sharp correction. The biggest booms have been restricted to specific cities around the globe – in the UK, Europe, the U.S., Australia, and places like Hong Kong.
According to The Economist, which recently published the chart reproduced below, the U.S. housing market is in the middle of the global pack. It still is in “recovery” mode and far from a booming Hong Kong or Turkey. But the concern is that the U.S. is on the verge of jumping from moderate recovery to overheating. Recently, house prices have outpaced income growth: The S&P/ Case-Shiller Home Price Index was up 4.7% in the 12 months to July while average hourly earnings growth has been about half that. In addition, new home construction hasn’t kept pace with job creation as it has in the past. Looking at house prices relative to income growth and rents, The Economist deems the U.S. housing market to be at “fair value.” This is consistent with the IMF’s finding of U.S. house price growth relative to income growth. Nevertheless, the risk seems to be to the upside.
The housing market inciting the most fear probably is China’s, one of only five countries in The Economist analysis where prices are falling. Everyone has been worried about massive oversupply that needs to be worked off, especially in second and third-tier cities, but no full-blown crisis has yet materialized. On the plus side, Chinese home buyers use relatively little leverage to purchase homes, which suggests a gradual cooling is possible. It’s the twin booms of housing and credit that create the greatest risk -- during the Great Recession, 21 of the 23 countries with both housing and credit booms suffered severe crisis. Still, sentiment around China’s housing markets is intricately tied up with overall concern about over-investment driven by plentiful credit.
Perhaps the most notable risk is in key booming urban markets around the world. Bloomberg recently listed 13 U.S. cities where millennials are priced out of the market because their incomes just aren’t sufficient to make that first home purchase. According to Bloomberg the five least affordable cities for millennials when it comes to housing are all in California – San Francisco, San Jose, Los Angeles, San Diego, and Sacramento -- followed by New York.