Wednesday, 30 July 2008

House Prices Stagnating, What Next? Who Is Buying?

As during the technology bubble, people were buying stocks that were clearly overvalued. Why was it? psychology and banks. Too many years of rising price and massive profit that led some to fall in euphoria and created a belief of a sure investment, an investment that will grow double digit for many years to come...In fact the reality was different, the Helsinki stock hexchange index never recovered from it's high after 10 years and it won't for at least another decade.

Today the same has happened for housing, people are currently buying an overvalued asset, why is that? same arguments as any bubble: psychology and banks. It seems today that the same idea of sure investment is clearly anchored in people belief, they cannot imagine prices going down even unthinkable that prices could head lower for another half, decade or two to come.

Nevertheless today chart, kindly copied from Statistics Finland Web Site, clearly show the start of a downturn. When housing correct, it is a slow and long process. It doesn't correct overnight as do stocks. On the other hand it's not that easy to sale as stocks : not as liquid.

Technically it will take about 6 years of decline to reach a stable ground to either plunge further or start rising, all depending on the competitiveness of the country and its ability to attract more foreigners. If one parameter is against rising housing price in the long term is the ageing of the population. As Katainen, "Uusimaa" Finance Minister, said after 2010, Finland's GDP will grow to 1-2% as opposed to an average of 3% in the past 100 years (I'm wondering how they did come with those figures, maybe the wars were compensated by phenomenal growth).

I like to depict the Finnish economy or housing price momentum as a heavy train that has been propulsed by lower interest rates and a good global economy. But beginning of January 2008, the Engine was cut... the train seems, for now, moving at a good rate, mainly due to it's past acquired velocity..but slowly it's losing power until it finally stop...restarting it needs lot of energy and time and might never regain the same performance as in the past...

That said, who is buying? I suppose, if you dig further you will notice that small flats are the one that have pushed price the highest, something last to fall in a faltering market. There was as well unusual transactions, such as the one Bank of Finland did in the second quarter, selling a vast amount of flat to a rental company. Indeed rental companies had still the capability to borrow to buy housing stocks from building company, I wonder which bank/mutual fund was dumd to lend, as it will surely byte them back.

Anyway I'm more enclined to think that prices will be in between Low1 and low2, the timing is the most difficult part here, it could be reach fast as seen in Ireland, U.S. , U.K., Spain or could be a slow process as in Japan so another 20 years (it's worth to note that Japan had the same ageing problem as do Germany).


Andrew said...

to maintain market prices various organisation have in the **past** stepped forward to spin the news in a favourable manner. Also traditional forms of finance were used.

Things seem to happen much much faster now. Finland cant spin stability in house markets when market finance does not originate from Finland. The miracle of the Nordic banking model could soon be just another story of capitalisations measures as we see in other markets.

Traditionally house prices were 'sticky' but nowhere can it be seen that this is the case any more. In France today offers are being accepted at 20% under according to an article quoting a British france based agent with 4 agencies together with numerous other supporting stories about Brits in trouble with finance in france. NZ turned last month from uncertainty into widespread recognition that prices have already fallen. In part because houses are being sold via the internet and all buyers get to see what is happening in an unspun manner.

I think you will and Anton will find you are totally wrong about the long drawn out phase of price declines.

There was yesterday information in a finnish newspaper about flats in the around 90-100 m2 range not selling well. I have been tracking flats for sale in helsinki and can confirm that this range has begun to tick up. Own home houses are so far not increasing in numbers for sale.

Given the flood of news ariving now the sentiment is likely to turn very very quickly so that by Autumn here it will be a different market. For this not to happen Finland would have to be living in some kind of alternate reality.

HousingFinland said...

I would agree with your analysis.

Transparency is greater today than it was a decade ago, people are better informed therefore have a better judgment although psychology can alter a rational judgement...

Another point I didn't highlight was the fact that some transaction of very expensive flats occured in the first and second quarter.
The contract could have been signed last year before the turn in sentiment (so prices tend to lag well after the economy has turned). And those high price give a false sense of stability in the statistics produced....

"I think you will find you are totally wrong about the long drawn out phase of price declines."

What do you mean? I have said that the hardest thing to put the finger on is the "Timing". It can go fast if the economy turn to the worse in 2009 or in the Autumn :->....

Anonymous said...

"People were buying stocks that were clearly overvalued. Why was that?"

Well I bought late last year, with the full expectation that prices would fall.

Part of it was that we were downsizing from a larger rented flat, and in the medium to long term the move will save money. I think that we are going to be facing some difficult financial times and one choice that I have made is to spend more now in order to reduce future costs. Example: spending on energy saving equipment now to reduce future costs of electricity.

A second factor was the fear that the credit markets would dry up and if I waited it would be harder to get a loan to make a move. In this case I probably was over pessimistic - the banks seem to have been making huge amounts of money available in the first half of the year, and only now things are drying up.

A third important factor is the wife is very happy with the changes - how do you put a value on that?


Eric said...

Dear Island Crow,

Not that it matters now, but perhaps it would have made more sense to move to a smaller rental flat and not risk your equity investment, while increasing your capital through the reduced OPEX.

I have no clue about the degree of leverage you took on the place but if 50% of a EUR300,000 is borrowings and the market drops by 10% (20%) the first 30 (60) grand is coming out of your pocket.

I hope your wife will be as happy at t1 as she is at t0 if any serious loss financial takes place in our household.



HousingFinland said...

- Banks have clearly not tighten credit, on the contrary it seems that some have even relaxed some rules...Here I'm refering to Sampo/Dansk Bank, that instead of the 25% down payment they were supposedely asking in the past, they are now demanding 20% (I suppose most of people have taken insurance (for how long?) instead of paying the down payment, or provided weak collateral )...The Bank of Finland statistics have clearly shown that in the first and second quarter the volume of loan is still growing and is quite massive...

-Each person situation is unique, but the rules is simple, as long as you don't buy for speculating and are plannning to stay over a long period then you should be fine...obviously it feels better to have an asset that gains instead of having losses, although on a longer term you will at some point break even and start to be on the green...same as stock, as long as you didn't buy an overinflated house that won't be a profitable investment...I have seen lately so many of them either old house at formidably incorrect price knowing that either they are powered by oil, or have lots of hidden cost...Regarding new buildings, clearly, the housing builder have put the price as retailers do before summer promotion, inflated by 20-30% at a minimum, then they will slash prices giving the illusion of bargains...

-Never contradict your wife ;->, Usually theirs sixth sense is not oriented toward real estate or stocks. I remember one friend telling me that in 1996, his wife didn't want to buy a flat in toolo for 90.000 euro as it was too the price of this flat has quadriple (buble helping too)...Another friend telling that his wife didn't want to buy a flat in the past decade, she didn't want to have any debt, and now she try to convince him to buy a flat ;->, I guess they might be some kind of contrarian indicators :-> .

To conclude, indeed the psychology and the timing was so high that for many it has been hard not to be tempted to buy a house...I guess it was the same as in year 2000 stock market, but I think a bit worse as people understand better what is a house as opposed to a stock...

Regarding Real estate price, they can differ from one area to another, some price might not be as inflated and so some will fall more than others.Regions will evolve differently in the next decade,the same old moto, "location, location"...

Same apply for the economy, no one knows how it will be in the next 1-5 years, same with people finance as each will evolve differently in a boom or bust period...

Anonymous said...

Thanks for the comments Eric. It was highly leveraged (83%) but we were expecting some money to come in (inheritance), so it is now way down. Also the € amount was way below the figure you quoted.

I work as a bookkeeper and that affects how I see money - my son's book on economics starts with saying that an economist's view on things would be very different from a bookkeeer's view! :)

When I compare the current costs (service charge + interest on the loan) with what I would have be paying in rent what I am currently saving represents a 5% return on the purchase price of the flat. So in terms of running costs I am getting a fair return.

This leaves the capital cost and possible/probable loss. [I know all about that as a place I bought in 1989 lost 50% of the value in the crash in the early 1990s (value from asking price for similar sized flat in same housing company).] Although I am getting a 5% return now that % should go up as more debt is repaid (and the rent market increases its price). So if there is a rapid decrease in prices in the next few years (which I expect) and we are forced to sell (which I think we might avoid) then we would have lost a lot of capital. If on the other hand we can hold it for an extended period of time then the savings from lower running costs would to a large extent cover loss in capital value. There is no clear outcome, but it was a risk that we were willing to take (and it is in a much better 'part of town' so it should hold its value better than the previous place we owned).

^this reflects some of my process of thought, but it in no way is a recommendation that others do what I have done. Each should judge the risks for themselves.


Anonymous said...

"Same apply for the economy, no one knows how it will be in the next 1-5 years, same with people finance as each will evolve differently in a boom or bust period..."

I predict a recession in Finland no later than the end of next year (US, UK, Spain, Ireland, Denmark, New Zealand etc. already well on the way).

The next recession will be deep and long.


Andrew said...

I have been following Tuusula property 5km north of the Airport around hyrlla, with the intention of buying something to raise a family in. The first property was just awesome but the wife did not like it. The price was then reduced a few times to -5% and now has been withdrawn 'for a holiday'. Nearer to civilisation there were a few much less rural properties but none of these was 'quite right' and now around 6 months later there are a number of these not quite right properties. Some are not really so bad at all but the feeling is that the market is going down and its worth waiting. Additionally there are 2 developments of townhouses here in Hyrlla which are not selling. Around 24 houses or more for sale. And there are new build flats for sale too. I am not in the market for them but you wonder if they can sell if there are relatively cheaper own home houses not apparantly selling. So from our point of view the market has turned already. This morning the 'wife' overheard a construction and a legal guy talking about exactly this local situation on the bus to Helsinki. The young lawyer wondering if he would keep his job in a recession, that the euro was better than the Mark and how bad would it get etc etc. A couple of local bankers have also suggested that the market has already turned but nobody wants to be the first to make the call.

HousingFinland said...

I agree with "Nov", the probability of having a recession worse than 2001 is very high, one similar to 1990 not impossible: different cause, but same effect.

US, UK, Australia were the engine of the global expansion, as being the biggest consumers aroud but are all but collapsing.

China, India, Brasil and Russia are fighting Inflation and start to see their export market slowly but surely shrinking.

Europe is slowing and fast, but the problem with Europe is with politicians that are promising higher purchasing power in a slumping economy, in order on one hand to prepare elections and on the other putting the job of the ECB harder as this imply higher salaries that could push second round effects and loss of competitiveness therefore making harder for the ECB to cut rates...

Bankers in Finland cannot tell anything directly about housing as all have real estate branches that have been clearly pushing prices and speculating in the past 5-10 years. Here I'm talking about Huoneistokeskus, Kiinteistomailmaa, Viva, OP-kiinteistokeskus, Habita...I let you associate them with major Finnish banks...

Eric said...

Hi Island Crow,

Thanks for the reply! Let me start by saying that I really liked your closing cavet.

This is the way I see thing [i.e. the main assumptions from a non-accounting perspective ;)]

I) An asset is only worth discounted value of its future cash flow.
II) Thinking in the context of renting vs. buy; renting is the same as buying but the lessor is giving you 100% financing for the asset in question and your rental expense is pure interest and the lessor retains the asset price risk, both upside and downside.
III) In Finland a couple can deduct about £3,000 a year from their taxes for interest payments but you need to pay a lot of interest to get the full amount (i.e. borrow a lot or mortgage rates have to increase even more).
IV) Normal maintenance expenses in Finland are €150 to €250 per KK for a rivitalo or kerrostalo. Say €1,800 to €3,000
V) Basically, III and IV net out so they can be dropped from the equation.

My anecdotal story:

My new lessor is charging 890/kk for something that's value would be around €220,000 to €230,000 which works out to 4.8 to 4.85 percent interest p.a. which is currently around the EUR risk-free rate. Most people would expect there to be a premium above the risk free rate. (If I assume a 2% risk premium above the rf rate it would imply that fair value of the place I am renting is around €160,000 based on the current rent).

So right now I am about neutral. If I was a lessor I would expect to make more than the risk free rate because homes are obviously not risk free. Since the days of capital appreciation appear to over in the Finnish housing market, there appear to be two possible paths towards equilibrium:

1) Rents (or rents saved by owning a home) increase enough to justify the current market prices of homes. That will likely not fly because people don't make enough in this country to pay much more than they all ready are.

or 2) Market prices decrease to more accurately reflect the intrinsic value that the asset can generate - or saves it owner from paying for an "equivalent" asset.

I am obviously betting on the latter over next 2-3 years by not being in the real estate market and mainly saving my capital in short-term fixed income investments to preserve capital. I hope this gets me the same place in a few years for 20 to 30 percent less money (i.e. 50 to 90 grand more of 2011 cash when I retire, which I hope I will be able to turn into more before I retire and figure out how to spend/enjoy before I die), and a better set of options to choose from when market becomes one where buyers are in control.

This text above is purely my personal OPINION. Remember - opinions are like assholes; everybody's got one.


Andrew said...

here are some price reductions for own home houses in helsinki since mid june 2008. There are more.

Aurinkomäenkuja 5, Puistola
458 000 € reduced from 480

Peilitie 12, Vartiokylä
395 000 € reduced from 439

Selim Lindqvistinkuja 2, Pitäjänmäki
475 000 € was 495

Sadetie 13, Malmi,
488 000 € was 498

Overall though houses are still selling and inventory not yet to june levels of 149 after falling to 128 beginning of Aug now at 141.

Local (to me) inventory in Tuusula seems to be heading upwards with 66 which seems high for a smallish area.

Also flats in helsinki 81-100 m2 noticeably up in listing today for some reason after slow movement higher. Other higher m2 slight decline since june.

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