House prices are a bit high in the US and crazy overvalued in New Zealand

I talked with friends in New Zealand (Tim and Jo) over the weekend who told tales that sounded like there is a housing bubble in New Zealand, so I looked up some data at The Economist magazine and sure enough, massive bubble. There are two main references for measuring a housing bubble. The first is the ratio of prices to buy versus the cost to rent. If housing prices are driven by economic fundamentals, rents and prices should both rise or fall in parallel because the same things that make a location desirable to own should make it desirable to rent, but housing prices fluctuate much more than rents. By this measure, New Zealand is in extreme bubble territory and the US is only moderately overvalued on average:

The second measurement to diagnose a real estate bubble is the ratio of housing prices to mean disposable income. You might think that I would prefer median income, but this is one of those places where mean income probably does a better job because rich people spend A LOT more money buying houses than people below the median, so mean income is a more useful measure.

The main determinant of housing prices is the income of the people who live in the area. Whenever local incomes rise, local housing prices rise and vice versa.  Again, by this measure New Zealand is in super-bubble territory with the highest percent of household income going to housing of any nation in the OECD database.

Remember the fabled US housing bubble that crashed in 2007 and brought down the global economy?  That bubble was tiny compared to what is happening now in New Zealand.

In the very long run, the real (inflation adjusted) rise in house prices is very, very low because although land values have risen, construction technologies have reduced the real cost of building, just like with almost all other manufactured goods.  Some people think that rising population would cause housing prices to rise, but if dense population caused prices to rise, then Japan would have some of the least affordable housing in the world, but the Japanese spend a smaller fraction of their money on housing than Americans and British people do:

Chart 1

Robert Schiller estimated the real change in housing prices over two centuries and concluded that they stay pretty constant in the very long run so a final way to examine whether there is a bubble is to compare current housing prices with the real, long-term average price history as in the graph below.  This measure also confirms the earlier data: US housing is a bit overvalued whereas New Zealand’s prices are stratospheric.

Note that Australia and Canada have real estate price histories that are extremely similar with that of New Zealand. It is almost like they have the same economic forces acting upon them (high immigration being one factor in common) and those forces are completely different from what is happening in the US real estate markets. The British market is somewhere between the New Zealand pattern and the US pattern.

Where is the money coming from to blow up those bubbles?  I doubt it is a repeat of the securitization scam that caused the US housing bubble.  My best guess is that it is coming from immigration policies that award citizenship to rich foreigners who bring a large lump of money into their new nations.  Those foreigners have the money and incentive to buy real estate.  But that is just a guess.

The bottom line is you should avoid buying real estate in Australia, Canada, and New Zealand because it is currently cheaper to rent and sock away savings in other places. According to the Economist magazine data, these are some of the very biggest housing bubbles in history.  People in those nations don’t have a memory of a major real estate crash (at least since 1970), and if they are like people in most nations in a similar situation, they are probably spreading urban legends about how real estate is the safest investment because it rarely ever goes down in value.  That is the kind of story most Americans were telling themselves in 2007, just before the housing crash caused the Great Recession and that is what many Japanese were saying in 1990 just before their housing crash led into their lost decade. The Japanese housing market still has not recovered and that bubble was tiny compared to what is going on in New Zealand, Canada, and Australia.  Housing crashes are extremely common as shown in the international data at the Economist link above. Nobody knows when the crash will come, but it will come.

In fact, because housing crashes are so often accompanied with overall economic malaise, it would probably be a good idea for residents of the bubble markets to diversify their investments into foreign stocks.  Their domestic stocks should emphasize companies that do a lot of exporting rather than companies that rely upon domestic consumption.  Be particularly careful about buying stock in domestic banks that specialize in housing lending.

Update: Here is the data about the growth in the housing-price/rent ratio since 2015 presented as a map by Jeff Desjardins:


Posted in Globalization & International, Macro, Real Estate
One comment on “House prices are a bit high in the US and crazy overvalued in New Zealand
  1. […] in Canada were interested in the evidence I wrote about earlier of the housing bubble in New Zealand, and the story is nearly identical for Canada, so this is a copy of my prior post with graphs […]

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