Feet on the ground

December 25, 2015

There is an old piece of wisdom relating to markets, to the effect that the sector at the center of the last boom or bust will not – indeed cannot – play the same key role in the next cycle. Recent history amply bears this out: the technology sector that was the star of the late 90’s and crashed so dramatically at the turn of the century, was a minor player in the next cycle – in which finance and, above all, real estate, were the epicenter of a mania of historic proportions, which duly resulted in a collapse of equally historic magnitude.

It is therefore unsurprising that real-estate is not at the forefront of the current boom, nor will it be a leading player in the developing bust. That role, apparently, is reserved for the commodities sectors in general and the energy sector in particular, where the collapse is not merely underway but actually quite far advanced, with the bankruptcies beginning to pile up.

Even so, the quiescence of the American real-estate sector is remarkable. Much attention has been grabbed, understandably but quite disproportionately, by the speculative excesses visible in very specific corners of the real-estate market – luxury apartments in Manhattan and houses in the Hamptons are an outstanding example. But these are actually exceptions that prove the rule, because the main driving force behind the spike in these niche markets was foreign money, mainly out of China and Russia, rather than domestic American money.

Compare that to the peak of the mania, back in 2006, when Americans of all sorts were scrambling to buy and flip apartments, condos, houses and anything else that looked like ‘real-estate’. Their activity had a few outstanding nodes – Miami, Vegas and Phoenix, for example, but it encompassed most cities across the US.

However, the frenetic activity of speculative buyers is hardly the only element of the mania that has gone missing in the current cycle. All the main components of the market have changed from wild kids to mature adults. Thus, on the supply side, the data show clearly that the level of activity on the construction sector – residential, but also most kinds of non-residential – is not only not excessive,  but is actually low, both in absolute terms compared to the historical record, and also in relative terms, taking economic, financial and demographic factors into account.

For example, given the financial environment of record-low, rock-bottom interest rates that has continued for seven years, it would be natural to expect enormous demand for mortgages on the part of would-be buyers of all sorts – and for banks to fall over themselves in an effort to meet this demand. That ought, in turn, to have driven prices up sharply. In fact, though, demand for mortgages is low, demand to buy is low and the rate of price rises is also moderate. How ‘illogical’ this behavior is can be seen by comparing the US market with neighboring  Canada, or European countries such as Germany, Sweden and Holland, or Israel, for that matter.

The difference between the US and these others is simple: they did not suffer a massive collapse in their banking and construction sectors in 2007-2009, large numbers of people were not financially ruined and large numbers of homes were not foreclosed – as was the case in the US. In other words, for Americans the trauma of the last crash was so great that even seven years of cheap money have not been enough to expunge it and to entice large numbers of ordinary people to engage (again) in real-estate speculation. It seems likely that a full generation – at least — will have to pass before another bubble can form in the American real-estate sector.

This reflects the fact that we are dealing with phenomena that are first and foremost psychological and social, and only secondarily economic and financial. In the latter years of the mania – say 2004-2006 – it was perfectly obvious to any rational observer that prices were detached from any underlying economic logic and that the results were likely to be, in one understated word, detrimental. This column said as much, repeatedly. However, rational and dispassionate analysis is useless if there are virtually no rational people willing to listen to it. That is the essence of a mass mania.

By the same token, in the immediate post-crash years very few ordinary people were willing to buy real-estate, even at prices that could be shown to be absurdly cheap. That remains the case, to a large degree, even today. But in addition to psychology, there is also sociology. If the older generation has been scarred by its experiences, the younger generation has simply been turned off.   Many young couples are unable to buy homes because of economic constraints, but many others do not want to own their own homes, even if their circumstances allow them to buy one.

This is part of a wider phenomenon known as ‘the sharing economy’, which stretches from the biggest purchases – namely homes – to minor ones, such as hotel rooms and even taxi rides. But, unlike these examples, the move from owning to renting one’s home is not technology-driven, it is a behavioral change with economic roots. It’s too soon to know whether it is more than a transient fashion, but if it is here to stay, it signals the end of the Anglo-Saxon world’s conceptual aberration, wherein most people believe that their home is an investment, rather than a consumption item.

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