The Real Question

If someone says that arguing whether it's a bubble or not is most of the time retarded, I have to agree. But when the discussion really turns into nonsense is when the arguments for it not being a bubble are just arguments for prices being high at the moment. The usual stuff about continuing high demand and "them building not enough houses", you know. You can argue for hours about the future demand and supply, and the best you can arrive at is some kind of understanding of if there is a "bubble" in demand, i.e. the current demand is not sustainable in the future, or if there is shorter-term supply issue that will be solved (by building more houses in the coming years). But in no way does this address the real issue: the bubble in the prices.

Having seen how one-sided the public discourse on house prices in Norway is, I think it's best to explain a bit further. A financial bubble (in house prices, in stock prices, in tulips - you name it), or what I'd like to call simply too high prices, is always a result of high demand against a supply that doesn't fully meet the demand (supply that fails to keep the prices stable). If bubbles are a result of high demand vs. low supply, how can you tell a bubble or non-bubble by focusing on how demand exceeds supply?

The real question you need to answer to detect if it's a bubble or not is this:

What is a fair, reasonable price to pay for a house, and where does the market price stand in relation to this fair price?

It is a hard -if not impossible- one to answer. So, as Daniel Kahneman has taught me, we might substitute this hard question with an easier one focusing on the demand and supply, and by answering that question we think we have answered the ultimate question about if it's a bubble or not. But we haven't.

Try to ask someone what is a reasonable price for a house in Oslo. I don't have any accurate answer to it. But I can tell it's not

• what the market asks for,
• whatever amount the bank (including government & parental subsidies) is willing to give you,
• "any price" because real estate is always a safe investment in the long-term, or
• "any price" because Statistics Norway says house prices will go up until at least 2016 and I'll sell in 2016.

If you have no idea of a reasonable price, and instead rely on the bullet points above when deciding to buy a house, you risk paying way too much. Let's say during 25 years out of 30 it's fairly safe to buy. That might help you sleep at night, but it's still a big gamble to take when we talk about the biggest financial decision in many people's lives.

I have to admit that I don't try myself to answer the real question in any detail. I think you just can't know the answer. Instead I rely more on the "second-level thinking" I introduced earlier, trying basically to understand to what extent the buyers are being blind to the price (= follow the bullet point criteria above). Understanding this and the price of, and access to, credit is crucial in my opinion.

Beware The Hockey Stick Graphs

                               

                                (Source: SSB.no)

A shortage of supply or excessive demand? These are two sides of the same coin, so there is no sense in arguing which one is the primary cause of the house price appreciation of last 10 years in Norway. From the "hockey stick graph" above we can see that there has been a big increase in net migration, timing of which coincides with the economic boom in Norway (which in turn coincides with oil price appreciation). This net migration has lead to a rise in demand for housing.

The supply side of housing is always slower to adapt to a change in the market, so it shouldn't surprise us that there has been a lot of talk about "not building enough". This is the classical housing bubble cycle: Demand goes up - supply doesn't follow fast enough - prices go up. Supply follows with a lag, supply misses (due to the lag) the flattening of or decline in demand, which leads to oversupply and falling prices. As if it wasn't enough with this natural lag causing imbalances in the supply and demand, you can add to the equation the rising speculative demand due to rising (paper) profits through investing in a second or third (or 6th) house. And just like with the equity market, we have the biggest number of speculative buyers when the prices reach the top.

It is just impossible to know for sure where the above graph will continue, although it does seem that it is flattening out and there is also talk about increasing unemployment. I have touched the subject of oil price in my first posts, and that will have a big effect on the timing. But not just that. Even if the oil price stayed at the current levels, you will eventually get a decline in migration. That's because economic cycles never die.

My point with this post is that the current house prices are not based on stable, long-term developments. They are based on cyclical factors that have been quite extreme in the past 10 years. The outlook for European and world economy has rarely been as foggy as it is right now (many experienced investors can confirm this). This is a time to build some "nest egg" and prepare for a roller-coaster ride - not a time to count on a rosy future and get indebted like never before?

I end with an anecdote: Perhaps a year ago I read from Dagens Næringsliv of some experts who were expecting the prices in downtown Oslo to become so high that only rich people can afford them. They were drawing parallels between New York, London, Tokyo and Oslo. Downtown Oslo can end up like Manhattan, they were basically saying. We are now talking about a city which is surrounded by huge forests not more than a couple of kilometres from the city centre, and where they only now have started to build houses on a former airport, a 15 minutes' bus ride from the city centre.

I know that spotting a bubble is not this easy. I know it looked like a bubble already in 2006. But what we can be sure of is that if the bubble is going to burst during the next couple of years, we will have no shortage of ridiculous examples of how blind and stupid people were and how everyone should have seen this coming!