Monday, June 27, 2016

Home Sweet Home - Property bubble (an example in Amsterdam)




Last time, in our Home Sweet home series, we discovered that:

1. For our parents, thanks to inflation, the house was a good asset: it used to raise in price and, with a fixed rate mortgage, the percentage of the monthly payment was becoming smaller and smaller through time.
2. Today, due to deflation, it may be convenient to stay under rent for some time, since the house is not increasing in value. In addition, interest rates are dropping: so I showed that by simply waiting one year, you actually ended up in saving money, even paying a high rent in the meantime.

This is something that it is completely counter-intuitive for the past generations. My father still uses to tell me that to be under rent is a waste of money. He is fundamentally right: it is the present world that works upside-down. But we have to live with that.

Let's discuss now an example of what a property bubble means.

In economy, we refer to a bubble as a condition in which some particular asset (it may be your house, but also gold, stocks, commodities, oil) is increasing its value without any apparent fundamental reason, simply because the people (or the investors) are so sure that the asset is going to raise its value, that they buy it. Therefore, there is a strong demand, the price of the asset raises, which on its turn stimulates more demand, which raises the price etc.

If you are not aware of what a property bubble is, and how to recognize it, you may end up very badly! Because all bubbles pop, sooner or later: the decrease in value occurs abruptly, in a very short time, and if you bought a house when it was very expensive, you may find yourself with a house whose market value does not even cover the residual mortgage.

Let's use this real example, taken from a house in a nice town close to Amsterdam, built in 1971.
NOTE: in the Netherlands in the real estate websites, you may find precious info about the past prices of the houses. In Italy it is not possible, real estate agencies do not provide this information.

Price as of 2007: 695000 €
Price as of 2009: 599000 €
Price as of 2016: 415000 €

So, in 9 years (from 2007 to 2016), the house has lost 280000 €, that is MINUS 40% of market value.
Bear in mind that if you had bought this house in 2007, you were paying roughly 5,3% of interest rate for a 30 year mortgage to the bank.

In such conditions, in 2016 you would still own the bank 525000 €. 
In other terms, the present market value of the house (415000) does not even cover the debt to the bank (525000)!
To put it bluntly: a TOTAL DISASTER! 

The question is: how do you realize that the real estate market is in a bubble? This is important, since you need to avoid buying a house when the price is close to its peak. 
The other question is: how is it possible that the houses first became so expensive and then lost so much value in the following years?

To answer the first question, that is to find the means to defend us and our families from a financial disaster, we need first to answer the second question.

In other terms, we need to understand what CREDIT is, how it is born, where it comes from, and what forces jointly act to expand it or to shrink it.

We will see that CREDIT and INFLATION are very tied concepts. And that they have a huge influence upon our everyday life. 

It took me years to understand these concepts and to join the dots: if you follow me, I am confident that you will have in a few weeks the tools to take better decisions.

TAGS: inflation, deflation, house, real estate, mortgage, bubble




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