SKOPJE, Macedonia, Sept. 23 (UPI) -- The five ghastly "Jack the Ripper" murders took place in an area less than a quarter square mile in size. Houses in this haunting and decrepit no man's land straddling the City and metropolitan London could be had for 25,000 pounds to 50,000 pounds as late as a decade ago. How things change!
The general buoyancy in real estate prices in the capital coupled with the adjacent Spitalfields urban renewal project have lifted prices. A house not 50 yards from the scene of the Ripper's last -- and most ghoulish -- slaying now sells for more than 1 million pounds. In central London, one bedroom apartments retail for an outlandish half a million.
According to research published last week by Halifax, Britain's largest mortgage lender, the number of 1 million pound homes sold has doubled in the last 3 years to 2,600. It has increased 11 fold since 1995. In Greater London, one of every 90 homes fetches even a higher price. The average British house now costs 100,000 pounds.
One is reminded of the Japanese boast, at the height of their realty bubble, that the grounds of the royal palace in Tokyo are worth more than the entire real estate of Manhattan. Is Britain headed the same way?
A house -- much like a Big Mac -- is a basket of raw materials, goods and services. But, unlike the Big Mac -- and the purchasing power index it spawned -- houses are also investment vehicles and stores of value. They yield often tax-exempt capital gains, rental income, or benefits from occupying them (rent payments saved). Real estate is used to hedge against inflation, save for old age, and speculate. Prices of residential and commercial property reflect scarcity, investment fads, and changing moods.
Homeowners in both Britain and the United States -- spurred on by aggressive marketing and the lowest interest rates in 30 years -- have been refinancing old, more expensive, mortgages and heavily borrowing against their "equity" -- i.e., against the meteoric rise in the market prices of their abodes.
According to the Milken Institute in Los Angeles, asset bubbles tend to both enhance and cannibalize each other. Profits from surging tradable securities are used to buy property and drive up its values. Borrowing against residential equity fuels overvaluations in fervid stock exchanges. When one bubble bursts, the other initially benefits from an influx of funds withdrawn in panic from the shriveling alternative.
Quantitatively, both in Britain and the U.S., a considerably larger share of the nation's treasure is tied in real estate than in the capital markets. Yet, the infamous wealth effect -- an alleged fluctuation in the will to consume as a result of changing fortunes in the stock exchange -- is equally inconspicuous in the realty markets. It seems that consumption is correlated with lifelong projected earnings rather than with the state of one's savings and investments.
This is not the only counterintuitive finding. Asset inflation -- no matter how vertiginous -- rarely spills into consumer prices. The recent stock market bubbles in Japan and the U.S., for instance, coincided with a protracted period of disinflation.
The bursting of bubbles does have a deflationary effect, though.
In its recent survey of global house price movements, The Economist concluded that real estate inflation is a global phenomenon -- though Britain far outpaces the rest with a 20 percent increase in house prices in the last 12 months. The paper notes wryly: "Just as with equities in the late 1990s, property bulls are now coming up with bogus arguments for why rampant house-price inflation is sure to continue. Demographic change ... Physical restrictions and tough planning laws ... Similar arguments were heard in Japan in the late 1980s and Germany in the early 1990s -- and yet in recent years house prices in these two countries have been falling. British house prices also tumbled in the late 1980s."
They are bound to do so again. In the long run, the rise in house prices cannot exceed the increase in disposable income. The effects of the bursting of a property bubble are invariably more pernicious and prolonged than the outcomes of a bear market in stocks. Real estate is much more leveraged. Debt levels can well exceed home equity in a downturn. As loans are not eroded by low inflation the burden of real indebtedness mushrooms.
With both the equity and realty markets in gloom, people revert to cash and bonds and save more -- leading to deflation or recession or both. Japan is a prime example of such a shift of investment preferences. When prices collapse sufficiently to become attractive, investors pile back into both the capital and real estate markets. This cycle is as old and as inevitable as human greed and fear.
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