Nice article. The one item excluded in the analysis is the fact that real estate is the one asset that already has a “wealth tax”, where the municipality taxes the value every year. In the Northeast, depending on one’s area, that annual wealth tax has increased from about 1pct to anywhere between 2-4pct. This confiscates a portion of home price appreciation, as it makes the house less affordable to a buyer. It is also a major drag on housing vs other areas of the country less reliant on real estate taxes for funding.
Great point, Jeff. That would go into the ''regulation & tax'' camp. Housing is an asset where regulators and policymakers can make quite the difference.
This is one of the reasons why California and other west coast real estate appreciate much more rapidly: low property tax rates AND strict rules about how much they can increase them, effectively grandfathering in MUCH lower property taxes for earlier purchasers.
Housing owned outright appreciates, creating the illusion of wealth. Housing owned with a 30 year mortgage at fixed negative real interest rates builds real wealth. There are 8 different kinds of leverage in a conventional mortgage. Can you identify them all? It’s very important to look at the liability side of the equation.
Didn't you write in the end game article that hard assets such as real estate WITHOUT a mortgage is the way to go? Or did you mean that this should be one of the best option if we really go into a deleveraging cycle? If so, when do you foresee this happening? I cannot imagine that this would happen anytime soon as the debt globally is just so high and currency debasement is your best friend in this situation. Maybe 10 years out?
Thanks Alf for the real estate article. Does this illusionary wealth creation in real estate continue for ever? I thought the demographics wasn't working in real estates favour. In Toronto we used to have approximately 7 year boom and bust cycles probably because of demographics. Other possible factors contributing to price increases include boomers contributing downpayment to their adult kids, foreign investing( with or without money laundering).
Hi Tony! Actually, this demographics cycle is helping. The amount of people turning 30-40y old (house buyers) against the younger part of the population is in an upswing cycle.
The 7y boom and bust cycle was rather driven by policymakers accepting economic growth and recessions - today, that's not the case anymore.
Interesting article. What do you think of all the ESG regulations that might come for house owners? (E.g. less good insulated house owner have to pay some taxes, call to install better heating systems,….) Those regulations in the future might make real estate more expensive for buyer and for owner.
Instead of just looking at housing starts to population growth, maybe look only at the percentage of the population growth that can actually afford the higher housing costs, as everyone else is irrelevant. If a growing population cannot afford to buy or rent - they stay home with parents, or they group together to buy/rent. So a fast population growth could actually skew the numbers?
also many have simply given up, why bother working hard when work doesn't make the difference, instead access to leverage at the right time in the cycle will outperform median wage by some distance.
When purchasing my home in 2020, the closer told me that the predominant factor in home buying activity over her 20 year career was unemployment rates. I think this structural factor is overlooked quite often. Plain and simple, you can't get approved for a mortgage without a job. While it's interesting to consider the macro level, on a micro level, having a job is significantly more important than prevailing mortgage rates to the average person. Something like 70% of Americans don't even understand the Fed and how interest rates work. It's hard to imagine a family staring at their Bloomberg terminal waiting for the 10 year to drop...
If you trend the 10Y from 1980 to the present, it looks like it will trend to 0% between 2030 and 2035. Do you think this will be the real estate "peak", or will we see negative rates?
Once real rates can't drop anymore, the acceleration in the housing price increase will slow down. The house price increase might still happen at a slower pace though: that will depend on several other factors.
Al, if your comparison of housing pricing to a 30 year bond is true, isn't the FED the marginal buyer in the market by buying MBS securities through QE? I think it holds true, that an MBS security is the bond you describe in your article and the FED has been buying those.
Thank you for sharing, Alf. I'm hoping to get your thoughts on my observations working in the "luxury" >$1m residential real estate markets in the US over the last decade. After all, the table stakes in several cities and destination towns are $1m+. While many of my clients have very high incomes, regardless of their source of income, the bulk of their wealth is in public and/or private equities. It has seemed to me like their home purchases and therefore the home values are largely driven by stock prices. For example, many luxury home markets saw a drop in demand and pullback in prices starting in mid 2018, which appears to coincide with reduced equity valuations. It was the first time in several years that luxury homes traded at a discount to their previous purchase price 2-3 years prior. Fast forward to 2021, and a constant rational that I've heard from eager home buyers is that their net worth had nearly doubled since 2019. You mentioned that real estate values perpetuate the wealth illusion, but my observation is that it may actually be the other way around. Am I'm seeing causation where there is only correlation?
You mentioned that low mortgage rates and high leverage fuel the real estate appreciation. I don't disagree, but to add to that point, it is staggering how many people I have transacted with across the price spectrum from $500k-$20m+ who make all-cash offers (typically their proof of funds includes a sizable stock portfolio) but obtain as much financing as possible. Often they can easily afford to pay all-cash, but finance due to the difference between mortgage rates and their rate of return, which may actually be one of their reasons for buying the home. Again, stock prices factor into the equation.
As a side note, this seems to create a problem for would-be buyers who have lower income / wealth as they get crowded out of their market by the high net worth individuals who easily outcompete to absorb the supply. Call it a "trickle down" effect or gentrification, it seems to me to be driven by the demand side, which seems to be driven by the wealth affect of increasing stock prices.
As the economy becomes more financialized and credit creation + lower real rates fuel asset prices, it's difficult to disentangle if equity prices drive house prices or vice versa.
Thanks again Alf. You make a complicated subject easy to understand. Is the situation similar in Australia (my home) as the market is white hot at the moment on the east coast especially?
Hi Alf, thank you for your article! As usual great work. There are some factors that will impact the long-term bullish trend and I don’t speak about demographics. Living in Paris, I observed that, during the last 3 years all prices rose for small units, 40m2 to 70m2 and we are talking about a 20 to 30% increase !!! Except for larger apartments …. We had a decline of about 3 to 5% in prices caused by lack of buyers in the city center. Moreover, there is not so much interest in apartments which starts at 1,5 M Euro+. So I think the market will rise overall but at some point, money from small buyers will flow into other assets caused by a too big entry for them…
For long-term affordability, one of the metrics I look at is mortgage monthly installment on a 75sqm apartment in a decent city / monthly median salary for a couple.
All assuming a 30y fixed mortgage and monthly median salaries rising by 0.5-1.0% per year max, and a couple buying together.
If this metric hits 50-55% or more, the upward trend gets tougher and tougher.
Today, a 75sqm apartment in Utrecht (decent city in NL) costs 425.000 EUR.
Financed with a 30y fixed mortgage slightly above 2% nominal rate, that's 1.600 EUR per month in monthly installments.
An average couple makes 5.000 EUR after tax here in NL, which means they spend about 30% on mortgage installments.
Way to go, even assuming constant mortgage rates over the long term and slow real salary increases.
Nice article. The one item excluded in the analysis is the fact that real estate is the one asset that already has a “wealth tax”, where the municipality taxes the value every year. In the Northeast, depending on one’s area, that annual wealth tax has increased from about 1pct to anywhere between 2-4pct. This confiscates a portion of home price appreciation, as it makes the house less affordable to a buyer. It is also a major drag on housing vs other areas of the country less reliant on real estate taxes for funding.
Great point, Jeff. That would go into the ''regulation & tax'' camp. Housing is an asset where regulators and policymakers can make quite the difference.
This is one of the reasons why California and other west coast real estate appreciate much more rapidly: low property tax rates AND strict rules about how much they can increase them, effectively grandfathering in MUCH lower property taxes for earlier purchasers.
Housing owned outright appreciates, creating the illusion of wealth. Housing owned with a 30 year mortgage at fixed negative real interest rates builds real wealth. There are 8 different kinds of leverage in a conventional mortgage. Can you identify them all? It’s very important to look at the liability side of the equation.
https://www.amazon.com/Homeowner-Wealth-Formula-Daniel-Amerman/dp/1736117505
I agree 101%
Hi Alf
Didn't you write in the end game article that hard assets such as real estate WITHOUT a mortgage is the way to go? Or did you mean that this should be one of the best option if we really go into a deleveraging cycle? If so, when do you foresee this happening? I cannot imagine that this would happen anytime soon as the debt globally is just so high and currency debasement is your best friend in this situation. Maybe 10 years out?
Thanks Alf for the real estate article. Does this illusionary wealth creation in real estate continue for ever? I thought the demographics wasn't working in real estates favour. In Toronto we used to have approximately 7 year boom and bust cycles probably because of demographics. Other possible factors contributing to price increases include boomers contributing downpayment to their adult kids, foreign investing( with or without money laundering).
Hi Tony! Actually, this demographics cycle is helping. The amount of people turning 30-40y old (house buyers) against the younger part of the population is in an upswing cycle.
The 7y boom and bust cycle was rather driven by policymakers accepting economic growth and recessions - today, that's not the case anymore.
Interesting article. What do you think of all the ESG regulations that might come for house owners? (E.g. less good insulated house owner have to pay some taxes, call to install better heating systems,….) Those regulations in the future might make real estate more expensive for buyer and for owner.
Good point! Never thought of that, thank you.
Love it - very clear explanation and great analysis
Glad to read this!
Another great piece, thanks Alf! 🙏🏻
Thank you!
I just recently found you on youtube
Easily one of my top favorite macro thinkers
Keep up the impressive work
Thank you, very kind!
Instead of just looking at housing starts to population growth, maybe look only at the percentage of the population growth that can actually afford the higher housing costs, as everyone else is irrelevant. If a growing population cannot afford to buy or rent - they stay home with parents, or they group together to buy/rent. So a fast population growth could actually skew the numbers?
also many have simply given up, why bother working hard when work doesn't make the difference, instead access to leverage at the right time in the cycle will outperform median wage by some distance.
When purchasing my home in 2020, the closer told me that the predominant factor in home buying activity over her 20 year career was unemployment rates. I think this structural factor is overlooked quite often. Plain and simple, you can't get approved for a mortgage without a job. While it's interesting to consider the macro level, on a micro level, having a job is significantly more important than prevailing mortgage rates to the average person. Something like 70% of Americans don't even understand the Fed and how interest rates work. It's hard to imagine a family staring at their Bloomberg terminal waiting for the 10 year to drop...
Indeed, Tim. That's why I look at real wages too.
I can definitely see how those real wages fit in, especially today
What is your analysis of the demographic trends? I would have thought that the aging population would require less housing per capita, not more.
I will publish a detailed piece on demographics, stay tuned
If you trend the 10Y from 1980 to the present, it looks like it will trend to 0% between 2030 and 2035. Do you think this will be the real estate "peak", or will we see negative rates?
Once real rates can't drop anymore, the acceleration in the housing price increase will slow down. The house price increase might still happen at a slower pace though: that will depend on several other factors.
surely we've seen rates hit near bottom now we've had bouts of inflation, it only has to get near zero to be untenable, not actually hit it.
Al, if your comparison of housing pricing to a 30 year bond is true, isn't the FED the marginal buyer in the market by buying MBS securities through QE? I think it holds true, that an MBS security is the bond you describe in your article and the FED has been buying those.
The Fed has been a big marginal buyer, yes.
But MBS also qualify as HQLA for Bank Treasuries, so they will pick up the slack if returns are attractive enough.
a lot of layoffs going on in the US mortgage lending business recently. Most citing lack of volume.
So, due to the decrease in population size the rates has to decrease to keep up with the growth.
Can decreasing population result in less interest in the buy side in the long term?
It could be, but that will take few decades.
Doesnt lowering rates take approx the same time as the decreasing population?
Thank you for sharing, Alf. I'm hoping to get your thoughts on my observations working in the "luxury" >$1m residential real estate markets in the US over the last decade. After all, the table stakes in several cities and destination towns are $1m+. While many of my clients have very high incomes, regardless of their source of income, the bulk of their wealth is in public and/or private equities. It has seemed to me like their home purchases and therefore the home values are largely driven by stock prices. For example, many luxury home markets saw a drop in demand and pullback in prices starting in mid 2018, which appears to coincide with reduced equity valuations. It was the first time in several years that luxury homes traded at a discount to their previous purchase price 2-3 years prior. Fast forward to 2021, and a constant rational that I've heard from eager home buyers is that their net worth had nearly doubled since 2019. You mentioned that real estate values perpetuate the wealth illusion, but my observation is that it may actually be the other way around. Am I'm seeing causation where there is only correlation?
You mentioned that low mortgage rates and high leverage fuel the real estate appreciation. I don't disagree, but to add to that point, it is staggering how many people I have transacted with across the price spectrum from $500k-$20m+ who make all-cash offers (typically their proof of funds includes a sizable stock portfolio) but obtain as much financing as possible. Often they can easily afford to pay all-cash, but finance due to the difference between mortgage rates and their rate of return, which may actually be one of their reasons for buying the home. Again, stock prices factor into the equation.
As a side note, this seems to create a problem for would-be buyers who have lower income / wealth as they get crowded out of their market by the high net worth individuals who easily outcompete to absorb the supply. Call it a "trickle down" effect or gentrification, it seems to me to be driven by the demand side, which seems to be driven by the wealth affect of increasing stock prices.
Would love to get your thoughts. Thank you.
Great thoughts.
As the economy becomes more financialized and credit creation + lower real rates fuel asset prices, it's difficult to disentangle if equity prices drive house prices or vice versa.
Thank you
Thanks again Alf. You make a complicated subject easy to understand. Is the situation similar in Australia (my home) as the market is white hot at the moment on the east coast especially?
Hi Steve, thanks for the kind words.
I would need to look more into it.
Hi Alf, thank you for your article! As usual great work. There are some factors that will impact the long-term bullish trend and I don’t speak about demographics. Living in Paris, I observed that, during the last 3 years all prices rose for small units, 40m2 to 70m2 and we are talking about a 20 to 30% increase !!! Except for larger apartments …. We had a decline of about 3 to 5% in prices caused by lack of buyers in the city center. Moreover, there is not so much interest in apartments which starts at 1,5 M Euro+. So I think the market will rise overall but at some point, money from small buyers will flow into other assets caused by a too big entry for them…
Kaz, this is a very good point.
For long-term affordability, one of the metrics I look at is mortgage monthly installment on a 75sqm apartment in a decent city / monthly median salary for a couple.
All assuming a 30y fixed mortgage and monthly median salaries rising by 0.5-1.0% per year max, and a couple buying together.
If this metric hits 50-55% or more, the upward trend gets tougher and tougher.
Today, a 75sqm apartment in Utrecht (decent city in NL) costs 425.000 EUR.
Financed with a 30y fixed mortgage slightly above 2% nominal rate, that's 1.600 EUR per month in monthly installments.
An average couple makes 5.000 EUR after tax here in NL, which means they spend about 30% on mortgage installments.
Way to go, even assuming constant mortgage rates over the long term and slow real salary increases.
I agreed with you Alf… still there is way to go, but everything it depends where are you living and cost of mortgage…