IIt’s finish. An era of steadily rising house prices spurred on by cheap money is coming to an end. Central banks have created a colossal housing boom and they will soon have to deal with the consequences of the bursting of the bubble.
In China, this is already the case. Banks in the world’s second-largest economy have been ordered to bail out property developers so they can complete unfinished projects. Mortgage boycotts are on the rise because people are, unsurprisingly, unhappy paying mortgages for properties they can’t occupy.
Sales of new properties have plummeted and new housing starts have nearly halved from pre-pandemic levels, posing spelling problems for heavily indebted property companies, the banks they borrowed from and the economy at large. The real estate sector accounts for about 20% of China’s gross domestic product. Rising real estate prices are already a thing of the past.
The US economy contracted for a second consecutive quarter in the three months to June and one of the factors was the rapid slowdown in the housing market. In the two years since the start of the coronavirus pandemic in the spring of 2020, US house prices have soared, rising 20% on the year to May. But the market is cooling rapidly, with the average price of new homes falling sharply in June.
Britain seems to be bucking the trend. According to figures from Halifax, the nation’s largest mortgage lender, house prices are rising at an annual rate of 13% – the highest in nearly two decades. Here too, the picture changes.
Last week, the Office for National Statistics released data on housing affordability, based on the ratio of house prices to average incomes. In Scotland and Wales, the ratio was 5.5 and 6.0 respectively, below the highs reached at the time of the 2007-09 global financial crisis. In England, the ratio was 8.7, the highest since the series began in 1999.
In England, there were regional variations. In Newcastle upon Tyne, the cost of an average house was 12 times the annual income of someone in the bottom 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 property prices have significantly outpaced wages.
There comes a time when housing simply becomes too expensive for potential buyers, but an extended period of ultra-low interest rates means it has taken time to get to that reality check point. Central banks have made the unaffordable affordable by keeping monthly mortgage payments low.
This is true all over the world, which is why from New York to Vancouver, from Zurich to Sydney, from Stockholm to Paris, the trend in real estate prices has continued to rise.
So far, at least. Western central banks are aggressively raising interest rates, making mortgages more expensive. Even before the US Federal Reserve announced a second successive 0.75 point increase in official borrowing costs last week, a new borrower taking out a 30-year fixed mortgage was paying 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 allowed buyers to take out fixed-term mortgages at extremely competitive rates, which hit a low of 1.4% last fall. But since December last year, the Bank has tightened its policy and these mortgages will increase when the fixed terms run out. Average mortgage rates are now 2.9%.
Central banks say the highest inflation in decades means they have no choice but to tighten policy – but they are doing so at a time when major economies are falling or heading into recession . The toxic mix for house prices is rising interest rates, collapsing growth and rising unemployment. Of these, only the last is missing, but if the winter is as bleak as policy makers predict, it’s only a matter of time before the queues get longer.
Last week, the International Monetary Fund released forecasts for the global economy that were decidedly bleak. Noting that the three main engines of growth – the United States, China and the euro zone – were at a standstill, the fund said that the risks were tilted strongly on the downside.
According to the IMF, there have only been five years in the past half-century when the global economy has grown below 2%: 1974, 1981, 1982, 2009 and 2020. A complete halt in shipments of Russian gas to Europe, stubbornly high inflation or a debt crisis were among the factors that could cause 2023 to join this list. A global real estate crash would guarantee that is the case.
That’s not to say there aren’t good reasons to want a purge of excesses from the real estate market. Soaring property prices discriminate against the young and the poor, lead to a misallocation of capital into unproductive assets, and add to demographic pressures by discouraging couples from having children.
However, central banks are trying to fine-tune a soft landing in which the downturn is short and shallow, and the rise in unemployment is enough to ease upward pressure on wages but remains modest. A housing price crash is not part of the plan as it would ensure a hard landing.
There is no appetite for a repeat of 2007, when the subprime mortgage crisis in the United States 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 prop up real estate developers and why Western central banks may stop raising interest rates sooner than expected by financial markets. We have been here before.