Looking at Other Countries' Bubbles

America does not find itself alone in a housing bubble, a number of other first-world nations around the globe are also caught up in the midst of a real estate bubble, many of which pre-dated America's bubble. The chart to the right, from the Economist article The Global Housing Boom - It Comes in Waves, shows how real estate prices have swelled in a number of countries over the past couple of years - clearly the United States is not alone.

Two previously hot real estate markets - Australia and England - have been cooling down as of late, with prices in some areas stagnating and in others dropping. Can the U.S. look at these countries as examples as to what may lie ahead state-side? In the article, Britain May Offer Clues to Direction of Housing Prices, author Shelley Emling writes:

What will happen when America's housing bubble can't expand any more? For answers, homeowners and buyers might look to Britain. Housing prices here have risen 165 percent over the past decade, making it one of several countries in Europe and elsewhere that have outstripped even the soaring U.S. market.

In recent months, however, those prices have been stagnant or even dropping. Some studies show that the housing market may be overvalued by as much as 25 percent in Britain and that it can take eight weeks or longer to sell a property here. Some real estate experts warn that Britain could be among the first dominoes to drop in a global collapse in property prices.

Many point to Australia, where the once-booming property market has been in the doldrums for the past 18 months or so. In Sydney, the average house price has fallen about 15 percent since the end of 2003, according to the Commonwealth Bank of Australia.

A lot of people - those working in the real estate world, it seems - dismiss the likelihood of a price drop. Rather, they expect to see prices merely stagnate or grow slowly. "It would take a recession," many will argue, "to cause house prices to drop." This argument has some merit. Classically, house prices are more resistant to price drops as compared to, say, the equity market, because there is considerable effort and time and money involved in offloading a house. Furthermore, real estate often doubles as one's home, and people do need a place to live so even if prices start to turn sour, home owners will be reluctant to sell unless they must move for a job or cannot afford their mortgage payments anymore. The aforementioned Economist article, however, argues that while classically housing prices are slow to drop, there is a greater chance with this global housing boom will cause a precipitous drop in prices:

The rapid house-price inflation of recent years is clearly unsustainable, yet most economists in most countries (even in Britain and Australia, where prices are already falling) still cling to the hope that house prices will flatten rather than collapse. It is true that, unlike share prices, house prices tend to be somewhat “sticky” downwards. People have to live somewhere and owners are loth to accept a capital loss. As long as they can afford their mortgage payments, they will stay put until conditions improve. The snag is that eventually some owners have to sell—because of relocation, or job loss—and they will be forced to accept lower prices.

Indeed, a drop in nominal prices is today more likely than after previous booms for three reasons: homes are more overvalued; inflation is much lower; and many more people have been buying houses as an investment. If house prices stop rising or start to fall, owner-occupiers will largely stay put, but over-exposed investors are more likely to sell, especially if rents do not cover their interest payments. House prices will not collapse overnight like stockmarkets—a slow puncture is more likely. But over the next five years, several countries are likely to experience price falls of 20% or more.

And while house prices are still climbing here in the US, many countries world-wide are seeing a much greater slowdown in pricing increases, some quickly reaching a point of total stagnation (as the graph below illustrates).