Why Real Estate is More and More Like a Global Financial Market: Getting Financial Returns When Everything Seems Maxed Out, Part II

In part I we explored where markets stand now and what elements are generally causes for major market drops. Other than stocks and bonds, real estate is another major market. Real estate can be decomposed into 3 broad categories:

  1. Housing (rental and owner-occupied)
  2. Commercial (production plants, stores, shopping malls, etc.).
  3. Public infrastructure (schools, roads, bridges, waterways, etc.).

Simplistic analysis views real estate as a goods market like any other: we have a need for housing just like we have a need for cars, hence the price should reflect “fundamentals” of demand and supply. For standard housing, the fundamentals of demand are essentially disposable income, demographics, job security and “household mood/confidence,” and willingness to pay, which itself is influenced by credit conditions (availability of credit and average mortgage rates).

Looking at the USA, Canada, Australia, New Zealand, and many others, one sees an interesting pattern: “global cities” have experienced unbelievable price increases over the last decade, FAR beyond any “logical” explanation such as demographics, falling interest rates, or income and jobs. With annual price increases averaging well over 6% in many markets, the total price change is nothing less than astronomical in the big picture in several cities. This can IN PART be explained by a “rebound effect” due to the price crash of 2007–2009, hence making the following years “bounce off the bottom,” but there are other factors at play. What’s happening?

https://www.thestar.com/opinion/editorial_cartoon/2017/04/23/greg-perry-house-prices.html

Global cities as financial markets

Allow me to freely define what I consider to be a “Global City” as a city with a few simple traits:

  1. A major city of the country in terms of population and economic activity
  2. High GDP per person (most OECD countries)
  3. Solid Rule of Law, with clear and trusted property law
  4. Political stability
  5. A large proportion of the population speaks English
  6. A relatively strong immigrant base
  7. Financial markets integrated to global markets

The more of these items are respected, the more the city is a “Global City.” Vancouver, Toronto, Montreal, New York, San Francisco, Los Angeles, Sydney, Auckland, and many other cities are “Global Cities” as described above.

Global Savings + income inequality + central bank money

The rise of global markets and solid growth in Asia and Latin America is a relatively recent phenomenon, as is the rapid rise of income (and wealth) inequality in many large economies. When you take Asia as a whole, the numbers are staggering simply due to demographics. Although GDP per capita remains low, a “small” fraction of the population in emerging markets has had a rapid rise of income and savings. China has a staggering 45% savings rate.

https://data.oecd.org/natincome/saving-rate.htm

Moreover, income increases worldwide are “unequal” and that means the ones getting extra income don’t need to spend it, hence they “save” it, which means they want to “park it” somewhere… in stocks, bonds… and real estate! Income inequality drives up asset prices, and housing in Global Cities are now simply just another “asset” in global financial markets for wealthy individuals of all origins looking to park and accumulate wealth outside of overpriced and risky stocks. Instead of buying and holding a bunch of stock at 100$ for a total of 500k, they buy a house or condo at 500k and they often do this via intermediaries within the country itself. The condo is more of a hassle than the stock, but they find on-the-spot aides that still that make this hassle go away, and the costs are reasonable enough to make housing an attractive destination for global capital. Note that if you see the global trends clearly, you will notice that there is considerable business opportunity in this segment of “helping the rich of the world park their money in real estate.” I just have no time to embark into this, but it is a vibrant niche… just sayin’. These global capital flows flock to places where downward price risk is low (large and important cities) and the general social and economic context is stable and trusted (Rule of Law and political stability).

The asset classes that now absorb global capital are thus:

  1. Stocks
  2. Bonds
  3. Land and real estate

We could add many others, like commodities and other more exotic categories, but they all essentially boil down to these broad categories.

The advent of zero and negative real interest rates and massive QE programs (central banks “printing” money) on a global scale has made credit free and plentiful, which simply added fuel to the rising phenomenon of global capital seeking returns and exacerbated the housing effect due to mortgage affordability for “normal” homebuyers.

This is why global cities have had significant price increases: the financial forces behind them compounded and all “planets” were aligned for major price increases. Currently there is a small monetary tightening, but it does not seem to be strong enough to curb the global trend, plus you have an increasing integration of China and India into global financial markets. For these reasons, I believe housing in Global Cities will continue mystifying those who continue looking at housing as a “market of places to live” rather than another financial market more like stocks. Please like and share, and follow me to keep getting the insights! Regards.