World house prices have grown faster than household incomes in recent decades as more cash and less mortgage lending is used. The number of years' wages needed to acquire a home is becoming less relevant as a result so it is unhelpful to call housing market ‘bubbles’ on this basis alone.
Housing capital is available through generational home ownership, historic price growth, inheritance, sale of businesses, bonuses, stock flotation, wealth creation, other investments, and so on. We therefore need to know how much housing capital people have to spend and how costly or difficult it is to obtain in order to talk about ‘affordability’.
What is 'affordable' in cash-rich cities?
A lot of housing capital has been concentrated at the top end of the housing markets in dominant world cities. These ‘prime’ markets provide good evidence of how mainstream markets outside world cities are behaving.
Prime markets in six major world cities grew by 80 per cent between 2005 and 2013 but prime income multiples in most of these are little changed in the last 11 years, at around 10 times local household incomes.
In markets like these, there is no direct relationship between incomes, borrowing, interest rates and values. So how do we tell what is fair value and whether the market is at risk of adjustment?
Prime markets are asset markets
The key to understanding prime market affordability and potential overheating is understanding the opportunity cost of capital. Put simply, you are paying too much for a house when the same money would buy you more of something else. Prime market affordability can therefore be assessed by comparing the cost of homes with the price of other assets.
We have looked at how many kilograms of gold you need in order to buy a prime (current value around US$3 million) home in the six top world cities. By comparing these numbers with how much gold you would have needed in the past, we can see whether any markets may be overheated and which may be in danger of a downward correction.
Our analysis shows that most prime housing values seem to be justified if only in relation to the price of alternative assets, in historic terms. While London, New York and Hong Kong cost more in gold now than the eleven-year average, only prime residential real estate in Hong Kong is currently priced near its 2007 peak. All the other world cities are still well below their peak gold pricing.
This suggests that global house markets are not headed for a crash (unless there were to be a broader asset price crash, including gold). London and New York might be described as fully valued rather than overvalued while, by historic standards, Paris, Singapore and Tokyo look fairly priced. Hong Kong is both more expensive and nearer its former pre-crash peak than the other cities.
What are the implications for mainstream housing markets?
For those not occupying some of the most expensive homes on the planet, this analysis still has meaning. Understanding whether markets are affordable, overheated or cheap now depends on understanding the value of capital as well as the cost of mortgage borrowing. It suggests that mainstream markets where capital is available may yet see further growth.