Never in history have so many middle class households been able to borrow so much against real estate at such low mortgage rates. In the last great debt bubble in the U.S. that peaked in 1929, the average household could not afford a house and had to put down 50% and get a 5-year balloon mortgage. Hence, home prices did not bubble as much as stocks and then they only fell 26% in the worst depression in U.S. history.
In emerging countries never have new middle and upper class households grown so fast, even though the average household similarly cannot remotely afford to buy a house in a major city like Shanghai. We shouldn’t be surprised at what happens after a major housing bubble bursts as Japan went through this starting in 1991 after home prices rose 160% in just 6 years and then fell 64% — and they are still down that much 21 years later as a smaller generation followed a large baby boom for the first time in history. The U.S. followed with a 130% bubble up in 6 years from 2000–2006.
The Japanese market went back just below where its bubble started in 1986. For that to occur in the U.S., home prices would have to fall 55% – 65%, not the 34% we saw at worst in 2009.Around the world, the greatest bubble by far occurred in Shanghai, up 525% since 2000, and in China in general. (China’s supposed to have a soft landing?) Mumbai saw a 400% bubble, Dubai 300% and Seoul 205%. The greatest bubble in developed-country cities starts with Brisbane, Australia at 210% followed by 180% in Miami, 170% in L.A. and 165% in Vancouver. There are many cities that could see real estate drop 70% to 85%!
The only cities that had major bubbles and have already seen them fully erased in the U.S. arePhoenix, Las Vegas and Atlanta. No other major bubbles have burst back to where home prices are affordable again, and major cities from Shanghai to London to Vancouver to Melbourne and Sydney, Australia, are still going up or very near their peaks.
These types of very strong areas always have the view that their bubble won’t burst because they are so special – but bubbles always burst, especially when they get to the 10 times income valuations that major California cities saw in early 2006, and now the above cities are near or above such valuations with Shanghai at 30 times income. The greater the bubble, the greater the burst — is also a very good general rule, even though the most attractive cities with the scarcest land for development typically are the last to peak.
The real estate bubble is like a popcorn popper with different markets frothing over and peaking at different times, but all will burst ultimately. Given that real estate is so local, the best way to gauge the downside potential of your home or commercial real estate is to find out what it was worth at the beginning of 2000 at best and the beginning of 1996 at worst. If you can’t take that much heat consider selling and renting for the next three years plus. From around early 2015 forward we could see the greatest bargains in real estate of our lifetime.