Are houses expensive or cheap?
The “For Sale” sign is down and moving boxes are unpacked.
Buying a house is a major moment in life and probably the biggest purchase most homeowners will make. The price will typically be several multiples of a buyer’s annual income. And it is key to have a ratio that is manageable, not leading to financial stress or – in extreme cases – foreclosure.
In fact, global organisations such as the International Monetary Fund (IMF) and Organisation for Economic Co-operation and Development (OECD) examine housing markets’ price-to-income ratios to gauge whether housing is within reach of the average buyer. They say if this ratio rises above its long-term average, it could be an indication that prices were overvalued, possibly in an asset bubble.
ING senior economist Ian Bright details the dynamic in the video.
A place that makes New York look cheap
The New York Times published an IMF chart last year under the title “A place that makes New York real estate look cheap” showing the ratio in New York was 6.2 compared with over 10 in Tokyo, Hong Kong, Shanghai and Beijing.
Economics professor David Blanchflower wrote in The Independent in 2013 how the ratio in the United Kingdom, as measured by the Halifax, had risen from about 3 in the late 1990s to 5.8 in 2007 – a ratio that did not “look sustainable in the long run”.
IMF deputy managing director Min Zhu blogged that “in the long run, the price of houses cannot stray too far from people’s ability to afford them” but there were some country-specific factors for housing cycles, meaning a one-size-fits all policy approach didn’t work. The topic is covered on the new IMF property website, Global Housing Watch.
Ageing populations to slow rises?
Some central banks in some countries have expressed concerns about the high level of house prices, including Germany’s Bundesbank (which argued in its February 2014 monthly report residential property prices in urban areas were 10-to-20% overvalued) and the Reserve Bank of Australia (which argued in its July 2014 research discussion paper that house prices in Australia were not overvalued – despite high price to income ratios – provided house prices continued to increase at a rate similar to that which occurred in the period from 1955-to-2014).
Meanwhile, the Bank for International Settlements argued in chapter four of its June 2014 Annual Report that an ageing of the population and slower population growth suggested that rises in house prices are likely to be slower in the future than in the past.
Don’t be fooled
When house prices remain higher than historical averages for a long time there is a tendency for people to accept the higher level, forgetting times when prices were much more affordable.
As a result, some may fall for the thinking trap of availability bias.
Being aware of the longer term level of house prices and how they relate to current levels may provide a benchmark against which one can stress test their finances to calculate the possible downsides of taking on too much debt.
Remember, like any investment, the prices of houses can go down as well as up.