This time last year, my wife called me and said the four words no husband ever wants to hear…
Honey, we have termites.
I shouldn’t be surprised. I mean, we live in Florida – everyone gets termites here. The pest-control guy had found the clue – a few bug wings. But where was the nest?
I found it soon enough, up on our second-story deck. The structure’s made of concrete, but the decking itself? Yep – plywood. Just walking around up there, you’d never see it. But the critters had bored a little hole through the tarpaper sheathing, steadily chewing away the wood underneath.
It’s not unlike the new U.S. real estate boom. It appears a bedrock of economic strength. But as I’ll show, events far away – in China – are now weakening this market in subtle, powerful ways, with repercussions for the U.S. economy itself.
When people talk about the rebound in U.S. real estate, primarily they’re talking about luxury homes. It’s the hottest, most lucrative end of the market. Sales for houses deck builder San Francisco priced above $1 million rose almost 9% last year, more than double any other price category, according to the National Association of Realtors (NAR).
Buyers from China are the ones setting those record prices. How?
One is sheer numbers. Chinese buyers account for nearly a third of all home purchases by foreigners in the U.S. (and nearly triple those of Canadians, the next closest nationality group).
Two, Chinese buyers are more than happy to pay above top dollar – their median purchase price is $523,000 – more than twice the U.S. average.
Three, cash is king – and Chinese homebuyers love cash. According to the NAR, 76% of Chinese purchases were all-cash transactions.
First Australia, Then U.S?
But what happens now, after a 40% crash of the Shanghai Composite Index, and a still-slowing Chinese economy?
If you read the headlines, the “expert opinion” is uniformly bullish on what China’s woes mean for U.S. luxury home purchases. The rationale is that further weakness in China will only spur mainlanders to buy more U.S. real estate, not less.
To me, that sounds like bubble talk. I heard similar rationalizations when I was a financial journalist, covering the boom and bust of the U.S. housing market.
Perhaps America’s luxury home realtors should look to Australia, where Chinese property buyers also drove up luxury home prices to insane levels. More recently though, sales have started to tail off in the places where Chinese buyers are most active – the two largest cities, Sydney and Melbourne.
And Morgan Stanley, in a recent note, became the first major financial institution to declare that Australia’s housing cycle has peaked. The bank’s analysts expect “further declines in auction clearance rates (i.e. sales) and house price momentum, with a negative impact on construction occurring over 2016.”
Could the U.S. luxury home market not be far behind? The anecdotal data certainly points in that direction.
Realtors in the San Francisco Bay area now tell local media that buyers from China are hitting the “pause button.” Another said she’s seeing price reductions among her high-end ($3 million and up) properties. A Sotheby’s agent told KCBS-TV, “It’s been a little slower now. I feel like there’s been some kind of shift.”
In Miami, where Chinese buyers were a rising force in the marketplace, luxury home sales fell 10.6% in the most recent quarter. The number of listings keeps rising too – up 15% from year-ago levels.
Even the Chinese themselves may be seeing the writing on the wall. I ran across an article on a Singapore-based website aimed at high-wealth, English-speaking Chinese recently. The title of the article? “Now Is Not The Time to Buy in San Francisco.”
The national data also raises an interesting point. In a midyear report, Realtors.com noted that the total number of foreign buyers of U.S. real estate fell 10% in the 12-month period ending in March. Yet the dollar volume of their transactions (we’re talking residential sales here), rose 13% to a record $104 billion.
Translated, it means fewer buyers chasing higher prices. To me, that says “bubble.”
So let’s say I’m right, and that bubble has peaked. What does it mean?
Morgan Stanley, in its recent call on Australia’s Chinese-fed housing bubble, believes the coming U.S. real estate slowdown raises the risk of a recession in the Land Down Under.
Could it happen here too?
Considering so many of these homes are purchased for cash, the risk to the banking system seems minimal.
On the other hand, homebuilders haven’t been this confident in years. This summer, the Wells Fargo/National Association of Home Builders sentiment index hit its highest level since November 2005 – just before the U.S. real estate sector went over the cliff.
Likewise, the boom in luxury residential sales spurs a Field of Dreams mentality (“If you build it, they will come”) among builders and developers. That means lots of speculative development, and ever larger orders for lumber, concrete, premium windows, cabinets and lots of other high-value building components.
What happens if real demand doesn’t meet expectations?