Our other post examines the current state of the Phnom Penh property market. This post explains what a bubble is and why property can behave differently from other asset classes.

What is a bubble?

A bubble is a situation where the price of something is higher than its fair (or intrinsic) value. That is, the price is above that supported by economic conditions (“fundamentals”). The fundamental value of an asset is the present value of all future cash flow that the asset will generate for its owner.

The causes of bubbles are not easily explained by economic theory. This is because bubbles, by their very nature, are not rational or driven by economic fundamentals. Speculation, unrealistic expectations and “animal spirits” – sometimes fuelled by news reporting and by those who are profiting from it – can lead to prices diverging from fair value.

Because it is difficult to observe intrinsic value (market fundamentals include expectations of future cash flows), bubbles are often only identified in retrospect – after a drop in prices.

Phnom Penh has experienced a property crash before. According to Bonna Realty Group, residential land prices in Phnom Penh fell about 30% in 2009 and a further 12% in 2010. They did not regain their 2008 peak until 2014.

An ad for pre-sale of Bangkok condos, suggesting a limited time to obtain one.

Bubble signs

In real estate, there are a number of signals that a bubble might be developing:

• Buying to flip, not for the cash flows. That is, buying solely because of an expectation of price growth and the ability to sell before too long for a profit. Exuberant speculation is a sign of bubbles in many asset classes, not only property.
• Falling or very low rental yields. That is, purchase prices growing much quicker than rents.
• An increase in buying from people who previously could not afford to invest in real estate but have been lured by lower “teaser rate” loans and other financial engineering to make it appear more affordable.
• Increasing rates of mortgage fraud, and/or increasing rates of loan delinquency or default.

Why is property different?

Property is not the same as other asset classes (bonds, shares, etc.) and property markets often tend to behave differently (for a while) from other asset markets. Why property is different:

• There is emotion tied to real estate ownership. A house is a home not only an investment. Further, more people think they understand property (most have had a house) than other assets.
• No two properties are alike (what economists call “heterogeneity”), so different prices can be justified. Two shares in Google are exactly alike and so trade for the same price, but no two houses are exactly alike.
• Supply comes on with a lag. It takes time to obtain finances, to design and to build. It takes at least three years to complete a condo development in Phnom Penh, according to Bonna Realty. Hence increases in supply do not smoothly and slowing increase the supply of housing but instead can be lumpy. This means a lot of supply can hit the market simultaneously, chasing too few customers.
• Lack of data transparency. Share prices are easy for everyone to see and listed companies must publish audited accounts. Bond prices and interest rates are also very visible. Accurate real estate price data are harder to obtain, partly because of the heterogeneity described above.
• Easy credit. Banks are used to providing credit for property and have standard products for it (mortgages). They are happier to lend for this purpose because of the collateral provided. In addition, a low interest rate environment (in part driven by the Cambodian government’s limited control of monetary policy) encourages many people to borrow.
• A belief that it property never falls. “As safe as bricks and mortar” is a myth.
• Lack of liquidity. You can’t sell 10% of your house if you need to raise cash or reduce your exposure. And you can’t sell it quickly if you lose your job, etc.
• Buildings depreciate. Shares don’t need repainting or a new air conditioning unit. When you buy a house, you buy land and the building on it. The land is where most of the value lies.

In Cambodia, a lack of alternative investments, even less transparency, unclear land titling, and foreigners finding property too expensive at home but cheap in Cambodia also differentiate the property market from those of other assets.

These differences don’t mean that it’s less likely for a bubble to happen in real estate, they make a bubble harder to spot and therefore more likely. They mean that market inefficiencies can build up for longer, with prices moving further from fair value, and persisting for some time.

Caveat emptor. Buyer beware.