Is there a property bubble?

AS A precursor to my Cebu real estate talk on Friday, Dec. 4 at Harold’s Hotel, I would like to digress from my usual family business column and focus on educating my dear readers on what exactly a “propery bubble” is and why businessmen have this innate fear of an impending bubble that may soon burst.

Knowledge is power and as a real estate practitioner for close to 28 years (long before I became a family business coach) and former advisor to major property players in the region, it is incumbent upon me to share my knowledge about the industry and continue to espouse real estate best practices in an era where competition has become so intense.

For starters, let’s define what a property bubble is.

A real estate bubble (or housing bubble for residential markets) is a type of economic bubble that occurs periodically in global or local real estate markets. It is characterized by rapid increases in valuations of real property such as housing until they reach unsustainable levels and then decline.

Investopedia defines a property bubble as a run-up in housing prices fueled by demand, speculation and the belief that recent history is an infallible forecast of the future. Housing bubbles usually start with an increase in demand, in the face of limited supply which takes a relatively long period of time to replenish and increase. Speculators enter the market, believing that profits can be made through short-term buying and selling. This further drives demand. At some point, demand decreases, or stagnates at the same time supply increases, resulting in a sharp drop in prices – and the bubble bursts.

Housing market indicators

The questions of whether real estate bubbles can be identified and prevented, and whether they have broader macroeconomic significance are answered differently by schools of economic thought. The financial crisis of 2007–2012 was related to the bursting of real estate bubbles around the world, which had begun during the 2000s.

In some schools of heterodox economics, notably Austrian economics and Post-Keynesian economics, real estate bubbles are seen as an example of credit bubbles (pejoratively, speculative bubbles), because property owners generally use borrowed money to purchase property, in the form of mortgages. These are then argued to cause financial and hence economic crises. This is first argued empirically – numerous real estate bubbles have been followed by economic slumps, and it is argued that there is a cause-effect relationship between these.

In attempting to identify bubbles before they burst, economists have developed a number of financial ratios and economic indicators that can be used whether homes in a given area are fairly valued. I will highlight two indicators due to the limited space.

Housing affordability measures

The price to income ratio is the basic affordability measure for housing in a given area. It is generally the ratio of median house prices to median familial disposal incomes, expressed as a percentage or as years of income.

The deposit to income ratio is the minimum down payment for a typical mortgage, expressed in months or years of income. It is especially important for first time-buyers without existing home equity: if the down payment becomes too high, then those buyers may find themselves “priced out of the market”.

Despite periodic reminders by the Bangko Sentral ng Pilipinas to banks to be mindful of their lending activities to property concerns, my observation is that lending practices have relaxed, allowing greater multiples of income to be borrowed. Some speculate that this practice in the long term cannot be sustained and may ultimately lead to unaffordable mortgage payments, and repossession for many.

Banko Sentral intervention

Our central bank announced it will enhance oversight of real-estate lending this year to help curb speculation and improve its ability to prevent a property bubble from forming. It ordered banks to further tighten their lending standards for commercial real estate loans and provide more details on collateral requirements and loan covenants, including real-estate disclosure on investments in stocks and bonds that fund property ventures and loans to developers of low-cost homes. Closer monitoring will encourage banks “to exercise more self-restraint,” according to Deputy Governor Nestor Espenilla.

Bangko Sentral ng Pilipinas Deputy Governor Diwa Guinigundo said in an interview that it was a preemptive move. “We don’t see at this point signs of strains in the market but we don’t want to wait for that. That’s the trick with asset bubble; when you see it, that means it has formed and you’re too late.”

Recognizing when a bubble may occur becomes easier with the ability to spot red flags in the areas of lending, spending and employment.

Together with the head of research of Jones Lang La Salle Mr. Claro Cordero, I will do a full diagnostic and recommend solutions so property developers can manage growth should an event like a property bubble happen.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s