Iit’s over. An era of steadily rising house prices spurred by cheap money is coming to an end. Central banks have created a colossal housing boom and will soon have to face the consequences of the bubble that is opening.
In China it is already happening. Banks in the world’s second largest economy are under orders to bail out real estate developers so they can complete unfinished projects. Mortgage boycotts are on the rise because people are obviously not happy paying mortgages for properties they are unable to occupy.
Sales of new properties plummeted and new home startups nearly halved from pre-pandemic levels, creating spelling problems for heavily indebted real estate companies, the banks they borrowed from, and the wider economy . The real estate sector accounts for around 20% of China’s gross domestic product. Rising house prices are already a thing of the past.
The US economy contracted for the second consecutive quarter in the three months to June and a factor was the rapid slowdown in the housing market. In the two years since the coronavirus pandemic began in the spring of 2020, US home prices have soared, increasing by 20% in the year through May. But the market is cooling rapidly, with the average price of new homes falling sharply in June.
Britain appears to be bucking the trend. According to data from Halifax, the country’s largest mortgage lender, home prices are rising at an annual rate of 13%, the highest in nearly two decades. Here too the picture is changing.
Last week, the National Statistics Office released data on the affordability of housing, based on the relationship between property prices and average income. In Scotland and Wales, the ratio was 5.5 and 6.0, respectively, below the peaks reached at the time of the 2007-2009 global financial crisis. In England the ratio was 8.7, the highest since the series began in 1999.
Within England there were regional variations. In Newcastle upon Tyne the cost of an average home was 12 times the annual income of someone in the lower 10% income bracket. In London it was 40 times, and it’s almost certainly higher now. The ONS figures cover the period up to March 2021 and since then house prices have largely exceeded wages.
There comes a point where housing simply becomes too expensive for potential buyers, but an extended period of ultra-low interest rates means it has taken some time to get to this reality checkpoint. Central banks have made the unsustainable accessible by ensuring that monthly mortgage payments remain low.
This has been true around the world, which is why from New York to Vancouver, from Zurich to Sydney, from Stockholm to Paris, house prices have been inexorably upward.
Until now, at least. Western central banks are aggressively raising interest rates, making mortgages more expensive. Even before the US Federal Reserve last week announced a second consecutive 0.75 point hike in official borrowing costs, a new borrower taking a 30-year fixed home loan was paying a rate of around 5.5%. double that of the previous year. This increase explains why fewer Americans are buying new homes and why prices are falling.
In the UK, the Bank of England cut interest rates to 0.1% at the start of the pandemic and left them at that level for nearly two years. This has enabled homebuyers to take out term mortgages at extremely competitive rates, which hit a low of 1.4% last fall. But since December last year, the Bank has tightened the policy and those mortgages will rise when the fixed terms run out. Average home loan rates are now 2.9%.
Central banks say higher inflation in decades means they have no choice but to tighten policy, but they are doing so at a time when major economies are either falling into recession or heading in that direction. The toxic mix for house prices is rising interest rates, falling growth and rising unemployment. Of these, only the last one is missing, but if the winter is as bleak as politicians expect, it’s only a matter of time before the subsidy queues get longer.
Last week, the International Monetary Fund published very bleak forecasts for the world economy. Noting that all three major growth drivers – the US, China and the euro zone – were stalled, the fund said the risks were heavily skewed to the downside.
According to the IMF, only five years have passed in the last half century in which the global economy has grown by less than 2%: 1974, 1981, 1982, 2009 and 2020. A complete halt to Russian gas supplies to Europe, stubbornly high inflation or a debt crisis were among the factors that could lead 2023 to be on that list. A global housing crash would ensure it is.
This is not to say that there are no good reasons for wanting an elimination of the excesses of the housing market. The soaring house prices discriminate against the young and the poor, lead to poor capital allocation in unproductive goods, and increase demographic pressures by discouraging couples from having children.
However, central banks are trying to end a soft landing where the downturn is short and superficial and rising unemployment is enough to ease upward pressure on wages but is still modest. A slump in house prices is not part of the plan because it would ensure a hard landing.
There is no appetite for a repeat of 2007, when the US subprime mortgage crisis triggered the near collapse of the global banking system and led to the last major recession before the one caused by the pandemic. This is why the Chinese government is trying to support real estate developers and why Western central banks may stop raising interest rates sooner than financial markets expect. We have been here before.