Bubbles in House Prices Aren’t Fully Inflated

December 25th, 2013

House prices are increasing, showing signs of bubbles, but they aren’t fully inflated, according to The Economist.

Homes in Australia, New Zealand and Canada are overpriced and there are bubbles in house prices in Britain and Sweden. However, in Hong Kong, prices continue to go up, increasing up to 20% in the past year. Furthermore, a Manhattan penthouse has been valued at a record price of over $50 million.

Robert Shiller from Yale University said that bubbles are a psycho-economic phenomenon that comes with very enthusiastic people, the news media participating, and people regretting not being in the bubble. The bubbles are then made bigger with more available credit.

GMO, a fund management group, said that bubbles are created when asset prices increase by two or more standard deviations above their real price with inflation. Even with overvalued homes, investors don’t sell because they find it difficult to arbitrage away bubbles. They also don’t know if the bubbles will go away with a drop in prices, or with long-term inactivity, where inflation will erode the real value of houses.

A country’s monetary policy and interest rates also play a role in the formation and disappearance of property bubbles. Rising house prices give the banks more confidence to lend people more money to buy expensive properties. But if the banks stop lending more money, house prices can fall. Low interest rates mean low interest payments, and high house prices indicate high returns for investors. But if interest rates go up, so do interest payments, and house prices and returns will plummet.