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Tulips
from Amsterdam,
the South Sea Bubble,
the Klondike Gold
Rush, the 1929 Wall
Street Crash, the
Japanese Economic
Miracle, Internet
shares --
bubbles
have always formed
in financial markets.
A natural desire
to earn a quick
buck with the minimum
amount of effort
ensures they remain
regular occurrences.
Though
the countries and
asset types may
change, market bubbles
tend to exhibit
the same characteristics.
Drawing parallels
with the tech share
boom, here's why
there appears to
be a bubble brewing
in the property
market.
1.
Excessive valuations
Pretty
obvious, but when
valuations go far
beyond the norm
and lose all touch
with reality, a
bubble is forming.
At the top, with
price to earnings
ratios of 200 and
price to sales ratios
of 600, tech valuations
had veered way off
course from their
underlying business
fundamentals.
Just
as profits drive
share prices over
time, so salaries
dictate house prices.
Most people need
a mortgage to buy
property and the
amount that can
be borrowed is determined
by their income.
During
the past 20 years,
data from the Halifax
indicates the average
house has been worth
3.7 times the average
income. Just before
property prices
dived in the early
1990s, houses were
selling for 5.0
times the average
wage. The Halifax
declared the ratio
for June this year
was 4.8 times --
well above the historic
average and approaching
record levels.
2.
New value paradigms
In
any bubble market,
some industry commentators
will justify current
prices by resorting
to a 'new paradigm'
of valuation. For
the 'new Internet
era' of profit hypergrowth
and 80% operating
margins, read 'affordability'
(the percentage
of income spent
on mortgage payments)
in the current housing
market. Trouble
is, like hypergrowth
and great margins,
the affordability
argument doesn't
stand up to history.
In
1992, at the bottom
of the last housing
cycle, the average
homeowner paid 22%
of his wage on the
mortgage. In the
fourth quarter of
2002, the figure
was 15%. So, the
affordability measure
says houses are
cheaper now -- relatively
speaking -- than
in the depths of
a recession (when
distressed property
sellers abounded)
and ahead of an
eleven-year housing
bull run. That doesn't
make sense.
3.
Pyramid schemes
Bubbles
traditionally exhibit
'pyramid' characteristics,
whereby prices rise
on circular or self-fulfilling
arguments. Internet
incubators were
a classic pyramid
in early 2000. Speculators
valued these shares
at many times the
market value of
their dotcom investments,
which in turn were
valued at many times
their true worth.
Read more.
Buy-to-let
(BTL) appears a
pyramid in the making.
There's plenty of
evidence to suggest
novice landlords
are withdrawing
equity from their
own homes to buy
properties to rent
out. It's a vicious
circle: house prices
go up, which provides
more equity to withdraw,
which fuels BTL
purchases, which
means house prices
go up...
In
the first half of
2003, data from
the Council of Mortgage
Lenders showed one
BTL mortgage was
taken out for every
2.3 first-time buyer
loans. Many housing
chains could be
on rocky ground.
4.
Deterioration in
asset quality
Remember
Blakes Clothing,
Knutsford and Jellyworks
-- cash shells whose
rapid share price
gains and blue-sky
plans lured numerous
punters on to the
tech bandwagon?
When such rubbish
experiences high
demand, it's clear
everything else
in the market has
already been purchased
and the buying party
will soon be over.
And
so it is with property
today. With mainstream
housing out of reach
for many, beach
huts, land without
planning permission
and house 'bargains'
in Morocco and Bulgaria
are now finding
favour. Interest
in these obscure
property offshoots
surely means the
housing market proper
is running out of
buyers.
5.
Premature warnings
The
final characteristic
of a bubble is that
it goes on far longer
than most sensible
observers expect.
By their very nature,
bubbles defy logic
and many calls of
trouble will be
made prematurely.
Perennial market
pessimist Tony Dye
thought there was
a tech bubble in
1995. Fed boss Alan
Greenspan remarked
upon the US market's
'irrational exuberance'
in 1996. The current
property boom has
similarly made fools
of many a bearish
pundit.
Doomsters
time it wrong so
often because they
are trying to anticipate
the unknowable.
It's never clear
what exactly will
cause sentiment
to change or problems
to occur in a particular
market -- and when
it will happen --
but
happen it inevitably
will. If turning
point 'triggers'
were clear, markets
would never form
bubbles.
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