Thursday, December 10, 2015 / Property Investment
There has been a lot of talk recently about a housing bubble here in Australia. Truth be told, there has almost always been talk of a housing bubble, these comments go hand in hand with any market growth.
The term bubble gets thrown around quite regularly, and we thought it may be worth having a look at the origins of the term and what it actually means.
As we know a bubble is an object which rapidly grows in size, and then eventually collapses in on itself.
The term of reference to a bubble when people are talking about the housing market is a metaphor for the belief that the housing prices have increased rapidly, but that they can not possibly remain at the level at which they have climbed.
Specifically the term relates to when the price someone is willing to pay for something deviates strongly away from the item’s real value or level of actual use.
Market value is when an item’s worth is judged by the amount someone is prepared to pay for it.
A bubble occurs when numerous players in a market push the price for a commodity so high that it becomes unrealistically expensive for how useful or integral the commodity actually is.
Perhaps the most famous record of a bubble occurred in the Netherlands in the 1630’s.
This bubble was built upon the market value of tulips.
This event is often referred to as Tulipmania, and is widely written about by various economists.
To give a quick snap shot of what the bubble did to the price of tulip bulbs, you can view the chart to on the right.
We can see the huge price spike that occurred in 1637, which was then swiftly followed by a very rapid reduction in value.
The rapid increase in value is the period in which economic players push one another to drive the prices into a bubble, the sharp decline is what is known as “the bubble bursting”
Within the space of a few years a tulip bulb went from having the equivalent price of an onion, to the equivalent value of a house. Exact figures and details are regularly thrown into contention, however the fact that tulips grew in market value well above their intrinsic value is not contended.
What Caused This?
As much as tulips and the Netherlands seem to be inseparable in many people’s minds, they are not actually native to the region.
Tulips were introduced to the Netherlands from the Ottoman Empire in 1554
The Tulip flower was considerably different to any other flower that was currently available in Europe, with much more vivid and impressive colouring.
These events coincided with a point in history when the Netherlands was entering its Golden Age.
Previously most wealth and resources had been invested in the fight for independence from Spain, yet as the Golden Age for Holland was starting their resources were starting to flow much heavier into trade and commerce.
As merchants gained their fortunes, they would show their success with luxurious homes surrounded by flower gardens.
The tulip became quite the status symbol
Unique Traits that Added to the Value
Tulips themselves added to their value by naturally having limitations in their supply.
It could take years for seeds to mature into bulbs which were capable of producing the sought after flower.
Adding to this was the introduction of a virus to the tulip family, and not in the way that one would immediately think a virus could control a commodity value.
The virus did not destroy the tulips, the value increase was not caused by a sudden lack of supply in the face of a high demand.
The virus actually altered the way in which the Tulip flowers showed their colour, making it possible for the flower to actually have two different colours on the same petal.
This change made the Tulips appear even more striking than their single colour relatives, and the new infected bulbs climbed even further in value.
A bubble forms when speculative investors start to enter the market. In the case of Tulips, they had quite a few years of steady growth in value. As the Netherlands started introducing them to the rest of Europe and exporting them, as the virus altered them for the better, and as their popularity in general was growing.
The bubble forms when people see the price rising, and therefore reasonably expect the price to continue rising.
This leads to people purchasing tulips (or in this case, it was often futures or contracts for Tulips in the future) not because they actually want the tulips for themselves, but solely because they constitute a strong growth in value and potentially a large pay out for their investment.
As prices are pushed up they reach a point in which they far outweigh their intrinsic value.
As some players liquidate their holdings or “cash out” this effect sees many others attempt to sell off their tulips.
As the market shifts to having more sellers than buyers, the prices begin to drop.
As the prices drop this causes some holders to become nervous about further price drops, and they then begin to sell of their holdings.
This eventually compounds and turns into a giant rush to sell of the assets before they devalue even further, ironically causing an even faster devaluation.
The sudden devaluation of a previously valuable asset is the process in which the Bubble is said to have burst.
Now it may seem rather obvious very quickly that there is a significant difference between investing in Tulips and investing in property.
The bubble itself is caused by a large scale deviation between the market value of and the intrinsic value.
Whilst real estate as well as tulips has every possibility to be effected by market value fluctuations, there is a significant difference in the intrinsic value of the investments.
The intrinsic value of a Tulip is almost non-existent, other than decorative purposes the flower’s only other use is to be sold later at a higher value. The Tulip.
The intrinsic value of a house however is that it can provide shelter and accommodation, as well as the structural value of the materials which it is built with.
Every person needs to have a place to live, whilst no body actually needs a flower.
Another chief difference is the fact that a property can be used to generate income, in the form of renting the premises out. When a speculative asset such as a tulip is purchased, it often does not have any potential for creating revenue, it comes in only as a cost.
One of the hardest things when it comes to establishing whether a certain market was affected by a bubble or not, is that you often can not decide at the time. A bubble is normally diagnosed retrospectively, which means that during the bubble build up that it is hard to call whether it will suddenly burst.
What we do know is that the Tulip bubble grew rapidly and crashed rapidly, but this was a bubble built upon speculative investment of a decorative flower, not an important asset that is necessary for people to survive.
The people claiming “this is a housing bubble” are generally referring to the sky rocketing prices that Sydney and Melbourne have been seeing. It is certainly true that these two cities have seen some astronomical increases in value, but this does not necessarily mean that the market values have actually outstripped the intrinsic values of the properties.
When we think of a market bubble, there is generally the anticipation that the prices will come crashing to a very seriously low value.
However, we also know that we have a growing population, that we often face housing shortages, that people will always need to live somewhere.
Essentially, it is up to you to decide whether you think Australian house prices will continue to go up, or whether it will dramatically crash like the value of Tulips did. We encourage you to do your own research, consult with the appropriate professionals when making any financial decision.