While property is heavily tied to the traits inherent in the local (regional) market, I fully expect that the next 20 years (or so) will be an extremely bad time for global property.  Here are potential some reasons why I expect property to broadly decline in value:

  1. High propensity for access to credit to shrink.
  2. Lack of new buyers entering into the markets.
  3. High propensity for increased property taxes in some regions.
  4. Potential for civil unrest in some regions.
  5. Potential for war in some regions.
  6. Declining fertility rates globally- threat of reduced population.

Characterising the Property Market:

The property markets exhibit all of the classic traits of a pyramid scheme, but on an intergenerational basis.  Property is buoyed  in real value by increased population densities (to a point- more on this), with more populous younger generations driving demand on the lower levels of the pyramid.  Choking the supply of new houses at the top, as governments are sometimes prone to do, while increasing the bottom of the pyramid tends to drive values over time.  In some areas (like London, Hong-Kong, or Tokyo) there is a serious lack of space which naturally restricts housing supply.

In addition, property prices have been inflated through mortgage loans over the past 80 years.  Loans act as an accelerant, with more individuals eligible for property than would otherwise be the case in a loan-less market- in short they transfer income from expected future earnings into the present day, thus buoying the prices in the short term.

It is also worth noting that property is far from a liquid asset- when the markets decline it will be difficult to liquidate. People may be stuck with their properties far longer than they expect.

Now we’ll take each point in turn.

A high propensity for the access to credit to shrink and lack of new buyers.

There are two considerations to this story- the demand and the supply side.  In some regions of the world the credit bubble popped in ’07-’09 with a bang.  While the supply of loans hasn’t dried up the demand for loans has not recovered from its 2006 peak.

 

fredgraph (2).png
This graph courtesy of the St. Louis Fed. shows the reality of the sluggish US mortgage market.  Despite declining rates on fixed-rate mortgages (as well as ARMs) the total mortgage debt outstanding has not broken above the 2006 peak.

This is unlikely to be entirely due to supply.  While banks did get their fingers burned (to say the least) in 2006, governments are supercharging the debt market by lowering interest rates on excess reserves.  It is quite likely that first time “buyers” who could potentially afford a mortgage simply do not feel confident enough to enter into long-term mortgage contracts, and are opting to rent rather than take on long term debt obligations, while first-time buyers who are not creditworthy are deemed to be too high risk by banks post-crisis. Cash purchase is likely the preferred method of house buying now, but either way decades of excess leverage need to be worked out of the system.

The situation above is not just limited to the US, but also the UK and Europe.

Other regions of the world.

Where the European and US markets tumbled in 2007, some parts of the world sneezed and kept going.  This includes markets like Australia, Canada and China.  Part of this is due to a lack of a severe credit crunch during the Financial Crisis in these resource rich economies.  The second part is due to international capital flows of “hot money” coming out of China.

Let’s take a look at London, because this is an interesting case of a bull trend in an otherwise bearish market, which helps to explain the other markets quite well.

regional-house-prices-ratio.png
The rate at which London property has outstripped the rest of the UK has been tremendous, borne by international capital flows into the UK.  However, this trend as of the 4th Quarter of 2015 seems to be reversing, as London property fell approximately 25% in the luxury market.

Capital has been fleeing China, other emerging markets and the Middle East for some time and looking for yield in assets all over the world.  This is quite evident in the London markets where the prices of luxury property have gone stratospheric, causing asset price inflation.  Good for property sellers, not so good for buyers who are still holding property.

The story has been the same in some regions of the US, like Detroit, as well as Canada, Australia and just about anywhere with relaxed laws for international investors.  The trend is driven by fear of taxation by government.  Of course, as I mentioned before, property is a fixed asset- very hard to liquidate.  A “five lane highway going in, and a goat trail coming out“, as one hedge fund manager, Kyle Bass, has quipped.  Good luck to these investors. I wish them well, because a market which has doubled decade over decade for the last six decades is not a market I want to be trapped in.

High propensity for taxes in some regions.

London is, once again, the perfect example of how this capital cul de sac is liable to work.  Foreign capital flows in, leaving wealthy individuals stuck with fixed assets on their balance sheets which the smart hands sell out into the buoyed demand.  The government will then (partly through populist necessity and partly through the need to survive) hike taxes on property holdings to try to increase their tax revenues. This will be a common theme over the coming years internationally, and it bodes ill for property in general.

As taxes get hiked the markets fall in value, as the markets fall in value, assets become liabilities.  In the absolute worst case scenario people will simply abandon and walk away from their property.  This seems ludicrous to most, perhaps, but it has historical precedence.  I would point out this would probably be the final rally of an increasingly desperate government that is struggling for funds.  It may never come to this.

Propensity for civil unrest in some regions.

Anyone who is familiar with Marxist writings (and their mark on Russian history) must be familiar with the Bolshevik Revolution.  While I do not agree with the course of the revolution, or the solutions implemented by the Bolsheviks who hollowed out their national economy and actually allowed their future political leaders to become wealthy beyond all imagination, it should be noted that the unrest started through economic suffering of the common people.  Namely the middle class and the lower class.

This highlights the problem with a widening rich/poor wealth divide and unrest tends to start slow and then accelerate rapidly.  The Arab Spring, for instance, was building for many decade, but exploded across the Arabian Peninsula and North Africa in a matter of months.

Potential for war in some regions.

Desperate governments turn to desperate measures, including measures to distract the wider population.  Wars are a great distraction, provided they do not spill over into your own back yard.

2014-01-27T205945Z_1898484319_GM1EA1S0DT101_RTRMADP_3_SYRIA-CRISIS_368370.jpg
Property in Homs, Syria.  No doubt five years ago these hollowed out high-rises had commercial value.

Declining fertility rates; threat of a reduced population.

There are many ways this can come about.  Fertility rates have already been in decline in the West for many years, propagated by the socialist system (taxes for healthcare, social security, etc.)

There is the possibility of disruptions to the global supply chain- war, famine, drought etc.  There’s possibility of a pandemic like the influenza epidemic of 1918- long overdue by the way.

If someone held a gun to my head and told me to pick a course for future human population growth, I would err to the downside.

This shouldn’t alarm readers, it is not intended to- we might have unprecedented population growth over the next five decades.  I am simply pointing to this as a risk factor for property in the future.

The goldilocks scenario for property.

Property will continue to increase in value if:

  • Global stability is maintained.
  • Population growth is maintained OR property supply is reduced at a greater rate than population declines.
  • Interest rates are taken increasingly negative AND the markets respond without a major incident.
  • Taxes do not increase.

If I had to invest in a property somewhere, I would be looking rural, not urban.  I see urban property broadly to be one of the worst asset class investments of the next half-century.

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