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Living in a Bubble

April 2016

Property as an asset class has seen some of the greatest bubbles in history when values crashed through the floor. Here is a glimpse

Investopedia defines a housing 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’. At some point demand decreases or stagnates amidst abundant supply, resulting in the bubble bursting. While the asset class, given its inherent nature of larger sized transaction and carrying costs, is less prone to witnessing bubbles, the scale and aftermath of the incidents occurred have left indelible marks on the financial course of the world. What more of evidence to this than the US Housing market collapse in 2007-2008, plunging the world into an economic crisis from which it is still recovering.

While real estate bubbles over the last century can be traced back to as early as a precedence to the Great Depression in 1929, recent history has been replete with a number of cases.

Japan: The Bank of Japan had lowered interest rates from 5% in 1985 to 2.5% by early 1987. This meant Japanese banks were flush with cheap liquidity, which found its way to the real estate segment. The Japan Real Estate Institute (2004) recorded 6 major cities having experienced a commercial land price increase to the tune of 302.9% in 1991 compared to 1985, while residential land and industrial land price jumped 180.5% and 162.0%, respectively. The vicious cycle led to an eventual bust leading to what has come to be known as Japan’s ‘lost decade’.

China: China has had its share of asset price surges, including real estate, most recent of which has been documented in the period 2005-2011. However, few would be in the know of the bubble which rose in the late 1980’s coming to the fore in the early 1990’s. The same traces itself back to a province, Hainan Island, emerging as the epicenter to the bubble burst. Estimates peg the housing prices in the region having moved from Yuan 300 a square meter in 1989 to Yuan 7,500 in 1992. The irrational buoyancy crept to other part of the economy which compelled People’s Bank of China initiate a tight monetary policy, raising interest rates and controlling credit growth. The bubble burst.

Ireland: In a recently released report, OECD Economic Surveys Ireland warns Irish property prices have strongly risen since their trough in early 2013. Such strong price rises may again spark a reinforcing spiral of higher property prices and credit leading to another misalignment of property prices and eventual burst that causes large losses in the banking sector. This is a stark reminder of the period between 1997-2007 which saw the economy witness a massive house price boom, recognized amongst the longest and biggest in Europe. The boom was fueled by strong economic growth, a low interest rate regime and loose credit conditions. This bubble burst in 2008.

In a recently released report, UBS Global Real Estate Bubble Index, notes that quantitative easing across the world has seen central banks more than triple the global monetary base since 2008, leading to lowered real interest rates. Inexpensive financing combined with bullish expectations has led to real estate prices decoupling from the real economy.

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