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Housing as an investment

Those who have been persuaded by the financial institutions and the media to get onto the ‘housing ladder’ largely on the grounds that it will be a good investment, might not have realised that in the popular game there are snakes as well as ladders whereby you can go down as well as up. This is largely due to the cyclical rhythm of the market economy (where it is better to buy when prices are low and sell when they are high, rather than follow the herd and buy near the peak when things have never looked better, just before it all turns to dust). Furthermore, there is a phenomenon at work behind all this that is rather revealing.

Within capitalism there’s a variety of competing asset classes for those who are looking to expand their wealth (primarily capitalists and large institutions, but also anyone else with some spare cash to invest). These mainly include equities (company shares), bonds (such as government gilt-edged securities), cash in savings accounts, and property (commercial and residential). Led by financial institutions like Barclays Capital and Credit Suisse First Boston, there is quite an industry comparing the performance of these leading asset classes. Some are far more volatile than others, with equities being the most volatile, cash the least so. But property has been the next most volatile asset after equities with considerable short-to-medium term risk attached to it. While historically performing better than cash or bonds, property has performed noticeably less well than equities too (even though shares are rightly viewed as risky short-to-medium term assets by most – apart from when there’s a bubble, of course).

The US sub-prime market

Such has been the rush to buy houses at almost literally any price that the fortunes of the housing market have spilled over to affect other assets. Most notably, in February and March world stock markets were adversely affected by growing problems in United States’ sub-prime mortgages, caused by what are now falling house prices there.

Sub-prime mortgages are those offered in the US to customers with poor credit ratings or already high debt levels. Because they are riskier, interest rates tend to be higher than those on safer (prime) loans. But as the US housing market falters, more sub-prime loans are going bad and at an even faster rate than expected, with over an eighth of them already in arrears (Money Week, 2 March).

The bursting of America’s housing bubble could have widespread impacts on US financial institutions and others who have exposure there (in the UK, this ranges from HSBC bank to construction firms like Taylor Woodrow). And it is perfectly possible that the UK housing bubble may follow suit, with similarly high prices and unsustainable levels of debt no longer being able to defy gravity. Indeed, the entire housing bubble phenomenon is wider than commonly supposed – while the US and UK economies have a particular problem with their housing markets, so do many other countries where identifiable bubbles also exist, from Ireland and Spain to New Zealand.

Where next?

Past history demonstrates that sooner or later, the current housing bubble will end in tears. When asset prices become completely disengaged from what is happening in the real economy where wealth is produced and value created, and are only sustained by ever increasing amounts of indebtedness, it cannot last – capitalism just doesn’t work that way. Its growth is not planned or smooth and some sectors expanding rapidly beyond that which the market can bear is a natural feature of the system. When the crash comes, it will return markets to more realistic levels that are more in line with real incomes and values, and this is what has happened on every other previous occasion.

Just as the major world stock markets (including the UK) lost a colossal 50 per cent of their value in the ‘dot com’ crash of 2000-2003, before beginning their more recent recovery, so – sooner or later – the housing market will follow suit. And two factors in particular could be the trigger for it when it happens.

The first of these is interest rates, which have already been moving higher, and this movement could be propelled further by the backwash from the US sub-prime mortgage problems. Increases in interest rates have been associated with housing market crashes on the majority of occasions they have happened, and for obvious reasons.

The second issue is unemployment. There is a noticeable but unsurprising correlation between movements of house prices in the UK and rising and falling unemployment. Rising unemployment in the mid 1970s helped burst that particular housing bubble, and it also played a major role in the housing market corrections of the early 80s and then of the early to mid 90s, both of which coincided with more general economic slumps. When unemployment began to rise again last year, house prices tailed off, much to popular concern, but since then unemployment has eased slightly and house prices have resumed their upward trend.

What will trigger the crash this time is impossible to tell in advance, even if rising interest rates and unemployment are the most likely causes. Interestingly for those who now see houses primarily as investments rather than places to live, competing returns on asset classes might also give us a clue.

One of the tell-tale signs of a pending stock market crash is when the earnings yield on shares – effectively the profits from capitalist enterprises in relation to share prices – falls below the yield on long-term government bonds, which gives a signal to investors and capitalists generally that the risk associated with owning shares is no longer worthwhile and that investments like gilts are more attractive, being safer and suddenly with a better comparative return. The two most significant stock market collapses since the 1929 Wall Street crash have been 1974, when the UK market, for example, lost three-quarters of its value, and the aforementioned 2000-3 tumble, when the market halved in value. On both occasions, the earnings yield on shares had fallen by some margin below the yield on long-term government bonds (on both occasions the gap was more than 1 percent).

The analogy for the housing market at present is this: if housing is now very much an asset class for investment purposes, it compares unfavourably. According to the Financial Times, the earnings yield on UK equities is currently around 7 percent and for 10 year government bonds just under 5 percent. The rental yield on residential property is now 4 percent and falling, which means that ‘buy-to-let’ is looking like a lot of debt and a lot of risk for a very poor reward (nowhere near enough to cover mortgage payments).

The lessons from this situation seem clear:

that in capitalism what goes rapidly up must come down at speed too, in housing as in much else;

the vast majority of people in society who do not own enough wealth to buy houses outright and who must effectively pay by instalments are likely to be squeezed ever harder by an uncontrollable financial system;

those attracted by the ‘buy-to-let’ bonanza, turning themselves into mini-rentiers in a bid to escape wage slavery forever, are likely to get their fingers burnt.

Sooner or later the bubble will burst, and it will be wage and salary earners without ‘independent means’ – drowning in debt – who are likely to be hardest hit, as the market economy solves a problem it created in the only way it knows.

DAP