Some people are investors. Some are not. But everybody has an interest in housing.
If you are not buying, you’re renting, but we all need a place to live. That is what makes an analysis of housing so interesting. And over the last year, with a raft of uncertainty flooding the economy, the housing market feels like it is at a bit of a crossroads.
Some analysts are calling for large-scale corrections, with headlines flying around of 10%, 15%, 20% declines. I wrote this piece last November arguing that the more dramatic forecasts were wide of the mark, failing to see how the doomsday scenarios could come to fruition.
But as the economy continues to reel amid a cost-of-living crisis, the Russian war in Ukraine and tightening interest rates, let us take a look at the updated landscape.
Why do people think house prices will fall?
First, the obvious part. Mortgage rates have gone to the moon, and for house prices, that is not good.
As the world emerged out of COVID, an inflation crisis the likes of which we have not seen since the 70s emerged. In order to counteract this, the Federal Reserve moved to aggressively hike interest rates. The aim of this is to suck liquidity out of the economy, suppress demand and ultimately rein inflation in.
This is how central banks battle inflation. The only problem is that, at the same time, raising interest rates suppresses investment and the economy at large. So while demand needs to be pulled in to reduce inflation, pull it in too far and you risk a recession. This is the tightrope that the Fed is trying to walk.
Unfortunately, inflation rose to such a degree that consensus forecasts have the economy contracting to the point of recession. We have already seen the UK face economic chaos and Europe struggle in the wake of the Russian war in Ukraine (and the accompanying energy crisis). These factors have led to predictions that the economy will contract, with house prices following along.
Mortgage rates have rocketed
Of course, there is something a lot more direct that is leading to predictions of house prices falling, and that is the all-important mortgage rates.
Central banks kicking up interest rates affects mortgage payments severely. The below chart shows how quickly mortgage rates skyrocketed, rising to the highest point since 2002 before peeling back slightly, but still 6.5% compared to close to 2.5% at the start of 2021. A jump that severe sends homeowners’ mortgage payments through the roof (pun intended, I promise).
While the US Fed has led the way with interest rate increases, interest rates have been hiked around the globe. Yet despite this, it is important to look at the market as a whole. There are nowhere near as many interest-only mortgages on the market today as in years gone by. Not only that, but these rising rates affect floating-rate mortgages the most, and these have fallen substantially across the developed world, as the below graph from the FT shows.
This is not 2008
Yet despite this, there is no arguing that mortgage rates will – and have – affected demand. But any extrapolation of prior periods of pullback or crises is naïve, in my opinion.
There are many jarring headlines warning of large-scale crashes, which are no doubt fuelled partially by the PTSD so many have from the Great Financial Crash (GFC). But this was a black swan event led by outright negligence in the housing market, triggered by a startling subprime mortgage crisis.
Today, the environment is totally different. It is difficult to imagine a subprime-led crash of that scale, as those weak points have been plastered over. Not only that, but since the GFC, banks have seen regulation tighten and their required capital reserve ratios increase significantly. This has led to a vastly healthier and better-capitalised banking system. Let us not forget that the unprecedented 2008 crisis and subsequent dent to housing were exacerbated massively by the chaos caused by Lehman Brothers and all the rest of the banking gang.
Additionally, we are starting from a higher point. I will recycle a graph I used from my last analysis on housing, which paints a hypothetical picture of a 25% decline in house prices this quarter in the US. It doesn’t quite sound as ominous when you phrase it like, “housing could decline to lowest levels in two years”, does it?
The above chart would be the ultimate bear case, however. A 25% drop would have cataclysmic ramifications and the above scenario likely transpires with the stock market pulling back significantly, alongside the rest of the economy.
But I use the graph to show quite how far house prices have risen in such a short space of time. The median sales price of a home was $322,000 in April 2020. Just over two years later, it was $455,000 – that is a 41% rise. Why buy a meme coin when you can buy a house?
House prices could still fall
I believe that the data and historical patterns show that house prices simply cannot fall to the level that these ultra-bearish scenarios predict. I am expecting some weakness, sure, but especially in big cities, there is a flood of demand for housing and not enough supply to meet it.
Add in the fact that the climate is healthier today – both in terms of bank capitalisation but also there is less household debt and the labour market has remained resilient despite rising interest rates – and housing prices should be better placed to withstand a recession.
The Great Financial Crash of 2008 saw house prices fall by 15% – 20% in some of the nastier-hit developed nations. With how different the system is today, I find it hard to believe that we have the climate to match that fall.
Yet, it can’t be ignored that there are several factors which not only point towards a slowing down in housing, but a fall – just not on that scale. Home-price to income ratios are not overly pretty, while affordability is even lower than 2008.
The reasons to be pessimistic are clear. Housing has already shown signs of softening, but only mildly. But this is not the same climate as 2008, and a housing crash, especially in popular spots and big cities, is hard to envision.
But with inflation still rampant (despite more optimistic data over the last month), a war in Europe and high-interest rates, there are still myriad bearish variables. The baseline expectation by most is that at least a mild recession is inevitable. Either way, there is a wealth of uncertainty and a tough time ahead for the economy, no matter what way you swing it.
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