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For most people, owning a house is considered the ultimate security. The default topic of conversation for most adults for the last 20 – 30 years has been house prices. We invest truly vast amounts of not only our wealth but also our future earnings in real estate. More than this, for many people the property they own defines who they are. There are 155 million square kilometers of land in the world. Some of it is worth nothing and some of it is worth a fortune. The most important concept to understand with real estate and any other asset is that it is we who give it value.
In 1819, Sir Thomas Raffles recognized Hussein Shah as the rightful ruler of Johor on behalf of the British East India Company and agreed to pay the new Shah $5,000 Spanish Silver dollars per year in return for the exclusive right to operate a port in Singapore. There are now apartments purchased for $5,000 per square foot on the island and actual land is worth many times this. How did this happen?
There are four significant factors in the value of real estate. The most important of which is the behavior of the government – it is they who control the supply of usable land, legal infrastructure and tax rates. Raffles established large amounts of parkland, the practice of free trade and the rule of law in Singapore and this approach was to continue after independence in 1963 under Lee Kuan Yew and now Lee Hsien Loong. This approach worked wonders for the second factor in the value of real estate which is economic activity – traders and merchants from Arabia to China flocked to Singapore to set up their businesses and enjoy the chance to build their lives with the promise of low taxes and protection. Singapore became the shipping and financial hub of Southeast Asia. The third factor is demographics - with so much opportunity on offer, Singapore’s population boomed - from 1,000 people in 1819 to 100,000 in 1869 to 5.5 million today. Lastly, the fourth most significant factor is interest rates - Singapore has generally speaking enjoyed low interest rates (SIBOR is slightly more than 1% right now) which reduces the cost of borrowing to buy property.
Today, these four factors still determine the value of real estate all over the world. Generally speaking, all of them have moved in a positive direction for increasing real estate values for the last 35 years. The result has been an historic global property boom. We shall examine each of these factors on a universal basis in order to understand this extraordinary phenomenon.
The behavior of the state has been generally exemplary since 1980. There have been no significant conflicts between major states and the Cold War and its proxy wars ended in the early 1990’s. Furthermore, governments’ attitude towards their citizens has improved – liberal democratic capitalism has been chosen over its inferior alternatives – communism in Eastern Europe, the USSR and China and bureaucratic socialism in the Indian subcontinent and Latin America. This has allowed billions of citizens to create wealth and buy property with confidence for the first time. However, the political situation in the Middle East is trending downwards and bankrupt governments are viewing property as a soft target for future taxation. In Greece there are now 40 different property taxes and this is trend towards more and higher property taxes is increasing in southern Europe.
Demographics have been extremely positive over the last 35 years with world population almost doubling from 4 billion to 7.3 billion. This has greatly contributed to increased real estate values. But this astonishing boom will not translate into higher real estate prices indefinitely. In the developed nations and also now China, populations are aging and people are having fewer children later in life. In Japan the population is actually shrinking. Eventually these factors will slow the economy.
The world economy has been transformed during this period by the interrelated phenomenona of globalization and the Internet. The majority of humanity no longer lives in the ‘third world’ but are now participants of ‘emerging markets’. This has added value to the factories of Shenzhen, the call centers of Manila and the shopping malls of Jakarta - and the real estate upon which they are built. But much of this explosive growth has been based on credit. This will not prove sustainable because interest rates will one day start to rise (and have already started to do so in Singapore).
The factor that has changed the most dramatically in the last 35 years has been interest rates. Since the end of the US dollar based gold standard in 1971, the bond and interest rate markets, (like all other markets) have become completely unhinged. In the USA, long term fixed rate mortgages rocketed up to 18% in 1981 but have since been declining relentlessly downwards – they are now 2.5%. Lending rates more generally are now astonishingly low – sovereign bond yields have turned negative in some 15 countries. As a result, borrowers have been sucked into almost infinite debt levels. In many cities an annual salary x 10 mortgage value has become normal.
The bad news:
Many people think that interest rates returning to a ‘normal’ 6% range is impossible - as it would be ruinous to the economy and real estate in particular. But as the infamous investor George Soros has explained many times, markets do not revert to mean but rather they revert to extremes. Bond markets and mortgage rates might not return to ‘normal’ and then stop – they may well go even higher than they did in 1981. A mortgage of $200,000 at 2.5% interest is a manageable $416 a month, but at 1981 levels of 18% it would cost a bankrupting $3000 a month. This would break our debt based real estate market. Worse still, as Soros explains, markets improve gradually - such as the 35 year bull run in bonds, but they collapse rather quickly. In Denmark it is now possible to get a negative mortgage – you get paid to buy a house on credit. This may well soon be the case in other nations. Under such conditions it is easy to understand how people go ‘all in’. But it is exactly this kind of behavior that brings a market to a climax and then collapse.
In his autobiography, Lee Kuan Yew - the founding father of modern Singapore, described how he supported his family as a black market trader during WWII. He recounted that at the end of the war he bought and sold soap and medical supplies with literally millions of Japanese issued dollars, whilst one of his trader friends bought a whole shop house in central Singapore for a case of whisky.
These are sobering reminders that the value of any asset class - no matter how solid it might appear - can change dramatically if the fundamentals shift. This reality includes real estate as well as gold and silver. A small amount of one’s portfolio in bullion still acts as insurance against the fundamental factors that favour real estate changing for the worse.
by James Cox
and The Safe House / Silver Bullion Team
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Silver Maple Leafs supply has stabilized and we currently carry more than 40,000 ounces.
Gold supply is fine.