Buy a house? You’ve got to be joking.

I just went looking at houses in Edinburgh today. Two-bedroom flats, mostly in very poor repair – certainly none done up to a modern standard. Mostly second-story walkup tenements, none with parking, let alone a garage, no yard, and about 80m2 in floor plan. Close to the city centre, but in a city of barely 500,000 people.

They ran between £167-320 thousand depending on the street. Median income in the UK is £20,000. hmm.

Of eight I looked at, I liked one: it was £320, and would need about £50k more invested, as it currently had no kitchen and the interior was broken down to the point of needing re-lining. (Rockwall for US readers, Gib for Aussies and NZ).

So… are the prices for property assets crazy? I think so.

As Warren Buffett famously stated:

“In the short term the market is a popularity contest; in the long term it is a weighing machine.”

Property is popular: that much is a fact. But what would the weighing machine read right now? No-one can know.

I cannot see a more reasonable answer than, ceteris paribus (“all things being equal”), about half the current price.

Are all things equal? Well, it is not impossible that we have crossed a threshold of population/lifestyle/earnings/available-land (take your pick or combination of factors) which means that buying a small and basically unpleasant property will now consume most of an employed professional’s life-time earnings. If we lived in the times of the “fifth element”, then prices are cheap.

But, we don’t live then. We live just a decade after a time when property prices had appreciated to the point where a “new settler” (new home buyer) could not buy a 1000-acre farm, but could afford a 2-bedroom house with a yard. Currently, a well-off professional might well not be able to afford that same dwelling.

You see this all the time. A rather plain-faced person, semi- or unskilled, dressed cheaply, taking a young couple around a house. The young couple are dressed well, arrived in a nice car, and are both skilled professionals, well advanced in their careers. But the person showing the house is the owner. Tax-free, their dwelling has reliably “earned” tax-free double or triple their income every year for the last decade. Work is foolish: luck of occupation, everything.

So, either a life-time of earnings is not too much to spend for strata title to 100m2 of land in a comfortable democracy in the 21st Century. Or, on the other hand, there is a massive bubble which will burst in the next few years.

People with houses can play a shell game in which they swap houses for nominal values close to infinity. But new entrants can’t play that game. Prices cannot go up beyond the income of the people purchasing them.

Asset inflation has been permitted by dramatic increases in personal debt. If the property market needs new entrants, then current prices must move back (plummet) when the current debt bubble is unable to expand further.

How close are we too that point? Well, we are now at the point where there are basically zero new home buyers at this point: only kids whose parents pony up the down payment can get in. In addition, many mortgages are interest only, 30 years.

Based on those two facts, I would say we are in a property over-hang not unlike the “diamond overhang”. What’s that?

Well, most beauty diamonds never trade more than once: as they are dug up they enter a direct to retail market where they are sold to couples and become heirlooms. If they ever re-entered the market, their price would plunge. You could not sell the stock of the market at current prices. Property is the same. There is a massive constraint on properties entering the market: almost no-one sells a property, because they’d just need to buy again: so the market consists mostly of swaps and heirloom transfers: the new-entrant market is a fraction of the total market.

People have decided that a house is like a diamond. So, there is no room for more growth? Will it crash, or stay level?

Unlike diamonds, houses get sold when their owners die. Therefore, just as this market rose quickly, it will fall quickly if and when retirees want to get out, and they have no grand-children to get in.

The only way out is for home-debt owners to vote to have their paper debt to be erased by (a big increase in) inflation. Can they? You bet. Most people will want a stack of inflation to increase their earnings, and erase their mortgage. So, don’t buy a house, don’t have money in currencies where house debt is high (UK, USA, Australia).

Denis Cheung might have his doubts too, I think? Trading off rain for high property prices

post-post script… just went and bought one against my own best advice 🙂 I still predict it will decline in value over the next 10 years.


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