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Global Real Estate – Where Are The Risks Residing?

 7 min read / 

Think about what a house means to most people. In addition to being a place to live, it also represents the single largest investment one is ever likely to make over a lifetime, typically purchased via a mortgage (i.e., leveraged). It is also relatively illiquid, certainly in comparison with other asset classes that households typically use as a store of wealth (cash, equities, bonds, etc.).

Moreover, it is not just bricks and mortar; people have strong emotional ties with their homes because their housing choice not only reflects their current social standing but also dreams and aspirations for the future. Can one imagine an asset more perfectly designed to be prone to bubble-like behaviour?

A Lesson from History

Unsurprising, history is littered with examples of housing market bubbles that end with an unpleasant bang, often with dire knock-on consequences for the broader economy. This was most visibly demonstrated by the downturn in the US housing market in the mid-to-late 2000s, which proved to be the catalyst for the Great Recession, the worst global economic downturn since the Great Depression.

Back then, when US house prices were sliding, and unsold inventory was piling up, a housing market recovery seemed a dim and distant hope. And yet, fast forward a decade later, and US house prices are almost back to pre-crash highs. What’s more, in many other countries the impact of the Great Recession on the housing markets proved to be so negligible that it barely appears as a ripple in an otherwise strong upward price trend.

As noted in a recent article, global policymakers may not have been able to generate a self-sustaining economic recovery, but they have been very successful at reflating asset prices, including real estate – see chart below.

(Chart 1: Nominal Residential House Price Index – Select Countries (2010=100); Source: Bank of International Settlements (BIS))

In light of the continued appreciation in residential house prices over recent years, there is growing concern that another housing market bubble, if not globally, then at least in several countries, has been created.

Where the Problems Reside

According to the OECD’s Interim Economic Outlook, published earlier this month, the high level of residential real estate prices in several advanced economies is one of the key vulnerabilities in the global outlook.

As can be seen in the chart below, based on one of the two most common valuation metrics (price-to-rent ratios), the OECD calculations show residential real estate valuations to be rather stretched in Canada, Sweden, Australia and the UK.

(Chart 2: Residential Real Estate Price-to-Rent Ratios; Source: OECD Analytic House Price database)

By definition, a bubble occurs when the price of an asset is significantly overvalued, that is to say, it becomes increasingly difficult to justify elevated price levels based on underlying fundamentals (not impossible, because one thing humans are very good at is torturing logic to minimise cognitive dissonance).

In such situations, it is the overriding optimism of the crowd, with unrealistically high expectations, which acts as the propellant for further price gains. Hence, one additional confirming sign of a housing market bubble would be high crowd sentiment towards real estate. However, looking at the latest global crowd-sourced sentiment heatmap for residential real estate there are no obvious overheating candidates.

(Chart 3: Crowd-sourced Sentiment – Residential Housing; Source: Amareos)

Does this mean that fears and worries, expressed by the likes of the OECD and shared by many investors, about the formation and therefore potential bursting of another housing market bubble are exaggerated? Perhaps, not.

The Source of the Problem

Drilling down to the country level, one finds some rather concerning sentiment trends – clear warning signs that residential real estate prices in some of the countries highlighted by the OECD are vulnerable to the downside.

Because of the illiquid nature of residential housing – lead times for selling and buying properties can range from several weeks to several months – what one observes is that often sentiment moves down well in advance of house prices. One saw this very clearly in the US prior to the housing market downturn that started in 2007 – see chart below.

Worryingly for the optimists, even though US residential real estate does not appear to be particularly overvalued, with a price-to-rent ratio in line with its long-run trend, similar crowd behaviour is unfolding. There has been a marked deterioration in sentiment towards US residential real estate over the past few months, dragging the index down to levels not seen since the Great Recession.

Most likely, this fall is attributable to the back-up in mortgage rates reflecting the combination of a post-Trump reflation mindset and a Fed more proactively seeking to normalise its policy stance. As such, this highlights a clear vulnerability in the event that US interest rates continue to trend higher.

(Chart 4: Crowd-sourced Residential Real Estate Sentiment – US; Source: Amareos, BIS)

What about the other housing markets where valuations appear stretched?

Problems Across the Globe

In Canada, the country identified by the OECD as having the highest price-to-rent ratio amongst advanced economies, one finds that crowd sentiment towards residential real estate has rebounded over recent months having been consistently negative for much of the past year – see chart below.

This suggests that robust house price momentum witnessed over recent quarters may have convinced the crowd that it was too pessimistic. While such price/behaviour dynamics are never an encouraging long-run phenomenon (it is the very essence of bubble behaviour), the uptick in sentiment momentum by the crowd suggests that the house price slump many view as inevitable may be postponed a while longer.

(Chart 5: Crowd-sourced Residential Real Estate Sentiment – Canada; Source: Amareos, BIS)

Similar crowd dynamics are also evident in Sweden, a country whose housing market the OECD considers to be just behind Canada in terms of stretched valuations. Sentiment, which was firmly negative for much of the past year, moved into positive territory in November and has since remained there.

By contrast, Australia, another housing market where prices have been rising sharply, and valuations look expensive, is seeing a rather different trend in crowd sentiment. Q1 house price data was surprisingly robust but, as can be seen in the chart below, unlike Canada, crowd sentiment has stayed firmly negative.

(Exhibit 6: Crowd-sourced Residential Real Estate Sentiment – Australia; Source: Amareos, BIS)

For an economy which has not experienced a recession in more than a quarter of a century, and where the doomsayers have repeatedly and incorrectly predicted a bursting of the housing market bubble, calling a downturn is always a dangerous exercise.

However, one must conclude that the negative tone of crowd sentiment towards residential real estate in Australia suggests an increased vulnerability, a risk the RBA rather unusually referred to explicitly in the minutes from its last policy meeting published earlier this week.

The Brexit Issue

Finally, in the UK, Brexit worries clearly have had a strongly detrimental effect on the crowd’s view towards the UK housing market. However, the latest figures from the Office for National Statistics (ONS) show that after a slight wobble last year, prices rose just over 6% in the 12 months to January 2017, hitting fresh record highs. This price rise stands in marked contrast to the tone of the crowd towards UK housing, which remains firmly negative – albeit less so than witnessed immediately after the June 23rd referendum vote (a general trend in UK crowd sentiment as noted in last week’s article).

In fact, the last time crowd sentiment towards UK residential real estate was this sustained and negative was in 2008 just before prices dropped sharply, a lead time most likely attributable to the illiquid nature of housing (as mentioned above). So, just like Australia, the UK housing market appears to be increasingly running on fumes.

(Chart 7: Crowd-sourced Residential Real Estate Sentiment – UK; Source: Amareos and BIS)

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Global Affairs

Breakfast Briefing: Space Race, Google in China and Zuckerberg

google china

Google to Open in Beijing

Alphabet announced that it will open an AI research facility in the Chinese capital yesterday.

Editor’s Remarks: Under CEO Sundar Pichai, Google has been recommitting itself to China after it had most of its services blocked in 2010 when it refused to censor search content. In recent months, the tech giant has been marketing its new TensorFlow AI tools to the Chinese market, which aligns with the state’s ambitions to become a world leader in AI by 2030. Google’s new facility will consist of a small number of AI researchers, supported by hundreds of Chinese engineers. Google expects to face stiff competition for talent given how local tech giants, Baidu and Tencent, are ramping up their own AI efforts.

Telegram Is Not for Sale

Telegram’s elusive founder, Pavel Durov, insists that his messaging service will remain non-profit.

Editor’s Remarks: Durov and his brother Nikolai founded VK, Russia’s answer to Facebook, before they were forced to sell their stakes to a Kremlin-friendly oligarch. The pair has since relocated and built Telegram, an encrypted messaging service that they insist will never be sold. A libertarian – having enabled Telegram users to even send messages that will self-destruct – Durov and his product have gained popularity among cryptocurrency enthusiasts. Durov himself is bullish about the prospects of cryptocurrencies and owns at least 2,000 bitcoins. Pundits, meanwhile, reckon that Telegram is worth in the region of $5bn.

Japanese Space Startup Raises $90m

Ispace Inc raised $90m from Japan’s largest corporates in a bid to reach orbit by 2019. 

Editor’s Remarks: Ispace is backed by Japan Airlines, Tokyo Broadcasting System Holdings and also government-backed Innovation Network Corp. of Japan. The company plans to sell advertising space on its spacecraft, which will then feature prominently in distributed images. However, Ispace also envisages the use of rovers that will offer a “projection mapping service”, which will essentially produce a tiny billboard on the surface of the moon. This is the latest announcement in what is rapidly shaping up to be a wider commercialisation of space exploration. Elsewhere, SpaceX and Blue Origin are developing reusable rockets, while Planetary Resources intends to mine asteroids.

Roy Moore Loses Alabama

Moore, who was backed by Trump, narrowly lost to Doug Jones, a largely unknown Democrat.

Editor’s Remarks: Moore’s election efforts appeared to have succumbed to allegations of child abuse that were made against him last week. Newcomer Jones won 49.9% of the vote against Moore’s 48.4% in deeply conservative Alabama, marking the Democrats’ first Senate victory in the state since 1992. Moore is a household name in Alabama but the accusations recently levelled against him have ruined his once impeccable reputation. Reluctant to concede defeat in his home state, Moore has said that Alabama must “wait on God and let the process play out”. Meanwhile, Democrats are jubilant that they have managed to reduce the Republican majority in the Senate to 51-49, which could impact Trump’s tax reform.

Zuckerberg Backs VR Firm

Dreamscape Immersive, a virtual reality (VR) company, is backed by 21st Century Fox, Warner Bros. and Mark Zuckerberg.

Editor’s Remarks: Dreamscape is developing new VR arcades for shopping centres and has just closed a $30m Series B funding round – 50% more than planned. Among its initial backers were Steven Spielberg, 21st Century Fox and Warner Bros. The company has now added to that impressive list the likes of Mark Zuckerberg and Nickelodeon. Dreamscape is capitalising on Hollywood’s interest in VR, which the film industry reckons will draw in greater numbers of viewers and provide an opportunity to raise margins. Dreamscape intends to open seven VR centres in locations across North America and the UK.

Keep reading |  4 min read

Asia

Google to Open Artificial Intelligence Centre in China

 2 min read / 

Google AI China

Google will be opening its first artificial intelligence (AI) research centre in China, despite many of its services being blocked there.

Fei-Fei Li, Chief Scientist of Google Cloud, said:

“I believe AI and its benefits have no borders. Whether a breakthrough occurs in Silicon Valley, Beijing or anywhere else, it has the potential to make everyone’s life better for the entire world. As an AI first company, this is an important part of our collective mission. And we want to work with the best AI talent, wherever that talent is, to achieve it.”

The research centre will focus on basic AI research, and will consist of a team in Beijing, who will be supported by Google China’s engineering teams.

Google’s search engine and its Gmail are banned in China. However, the country has 730 million internet users, making the market too large to ignore.

Google is not the only tech giant facing restrictions in China. Facebook is also banned, while Apple’ App Store has been subject to censorship. In order to comply with government requests, Apple removed many popular messaging and virtual private network (VPN) apps from its App Store in China earlier on this year.

China has recently announced plans to develop artificial intelligence, and wants to catch up with the US. However, human rights groups are concerned by China’s use of artificial intelligence to monitor its own citizens.

Keep reading |  2 min read

Europe

Europe Warns Trump on Tax

Europe Trump

Finance ministers from Europe’s largest economies have said that Trump’s tax plans breach global agreements.

Europe’s leading finance ministers, including UK chancellor Philip Hammond, penned a letter to the White House in which they raised the possibility of retaliation if the Republicans push on with their tax reforms. Europe is worried that Trump’s “America First” doctrine will undermine global trade patterns and escalate ongoing tensions between the US and its key allies. With the UK looking to its closest ally for support post-Brexit, it is unlikely that Hammond’s latest move will sweeten any future US-UK trade deal. Meanwhile, Trump is unlikely to care about shaking up current trading arrangements, given that he ran for office on the platform of making the US more competitive.

Keep reading |  1 min read

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