Is the global real estate market heading for a downturn?

A series of continuous interest rate hikes by many of the world’s central banks turned the switch on a bomb that had been rapidly inflating global home prices. Experts expect the increases to end the two-year rapid rise in home prices and that price growth will slow sharply.

However, the pandemic-induced housing boom is not over yet. Visits to properties in London are still attracting throngs of potential buyers. Homes are still selling for amounts that far exceed their asking prices.

Similar pressures are manifesting in other markets. In the US, home prices rose at an annual rate of 20.6% in March, the fastest since records began more than 35 years ago. In the last quarter of 2021, real house prices in the 38 countries of the OECD, the club of rich country economies, rose by 16% in two years. That’s the fastest pace since records began 50 years ago.

However, much of the impetus for price growth came from the rapid changes in low interest rate policies that central banks adopted to mitigate the economic damage from the coronavirus pandemic. Bank actions have lowered mortgage maintenance costs at a time when many households saved money during lockdowns. The rise of work from home has also increased demand and therefore prices.

In recent months, on the other hand, the highest consumer price inflation in decades has prompted many central banks to raise their official interest rates, which have set the benchmark for the broader financial system. Mortgage rates that lenders charge homebuyers are rising in response. In the US, mortgage provider Freddie Mac’s 30-year mortgage rate rose to 5.23% in May, the highest since 2009. It was low last November.

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Some signs of decelerating price pressures have already emerged. In the US, builder confidence fell in May and purchases of new single-family homes were down 17% in April compared with the previous month, the weakest since April 2020. In the UK, mortgage approvals in April fell to lowest level in nearly two years. Annual house price growth decelerated sharply to 9.8 percent in the year to March from 11.3 percent in February.

Further rate hikes by central banks are likely to push mortgage rates even higher. Markets expect central banks to raise interest rates by at least 100 basis points by the end of this year or early next year in the eurozone, Canada, Australia and New Zealand.

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Most analysts expect these increases to produce a sharp slowdown in home price growth rates. “We expect home price inflation to decline in the US and Europe as a result of rising mortgage rates and pressure on debt affordability,” says Barbara Rismondo, senior vice president at ratings agency Moody’s.

The European Central Bank warned in May that an “abrupt increase” in real interest rates could induce “corrections” in house prices in the short term.

Bank of England Governor Andrew Bailey took a similar view. “The direction of travel would be that an increase in interest rates would lead to a cooling off in the housing market,” he told members of the House of Commons Treasury select committee in May.

Economists say that, in addition to rising mortgage costs, factors contributing to the slowdown in housing inflation include the erosion of real incomes by inflation and the detrimental effect of the past boom on households’ ability to save for deposits. As a result, consultancy Oxford Economics predicts that house prices will grow more slowly in 2023 than they did last year in most countries – and that some countries will experience outright contractions.

% annual change line graph showing boom in home price growth is predicted to end

James Knightley, an economist at ING, says the rapid growth in US house prices over the past two years could “quickly flatten out and possibly reverse”.

In the UK, Andrew Wishart, Senior Property Economist at Capital Economics, predicts prices will fall in 2023 and 2024, with a cumulative decline of 5%. This “would reverse one-fifth of the increase in home prices since the start of the pandemic,” he says.

However, few analysts expect a sharp global contraction in property prices like the one that occurred during the 2008-09 financial crisis, when economic activity and incomes also plummeted around the world. This crisis caused five years of falling house prices in OECD countries. There has been an increase in repossessions, particularly in the US.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, says current conditions “are not 2006”.

“The Fed’s rate hikes will not force current homeowners to sell in large numbers, because very few homebuyers in recent years have taken out adjustable-rate mortgages,” he says.

The popularity of fixed interest rate mortgages is shielding many mortgage customers from the effects of rate hikes. In the US, the 30-year fixed rate home mortgage has become the most popular product. While other countries have lower proportions of fixed rate mortgages, the proportion has also increased in recent decades on the other side of the Atlantic.

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Improvements in the quality of mortgage loans offer additional reason for relative optimism. In the US, more than two-thirds of people new to mortgages have high credit scores, more than double the proportion before the financial crisis, data from the Federal Reserve Bank of New York show.

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In addition, historically low unemployment rates and a shortage of homes for sale are supporting housing demand in most advanced economies. The number of homes for sale in the US is at a near-record level, according to Redfin, a mortgage broker who has tracked data since 2012. Close to the lowest levels since records began more than 40 years ago.

Innes McFee, an economist at Oxford Economics, says that unless there is a rise in unemployment that creates large numbers of forced sellers, the consultancy does not expect “significant drops in house prices” in “most markets”.

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While rapidly rising prices are expected to reduce real incomes in most economies, many households, particularly the wealthiest ones, have accumulated large amounts of savings during the pandemic.

Jim Egan, head of securitized research at Morgan Stanley, predicts that the limited supply of homes, the significant equity many homeowners hold in their properties, and the healthy finances of homeowners will ensure that the market avoids following the same trajectory as the “great boom”. real estate and bust from the early 2000s”.

Rismondo says real estate markets in Europe and North America currently share some common traits – “the desire for more space in a post-pandemic world, healthy household balance sheets, healthy labor markets, solid wage growth and the fact that many homeowners have blocked low-interest financing.”

Rismondo accepts that higher interest rates will reduce demand for credit for home purchases. But she says she hopes these “common factors” will provide some support for home prices on both sides of the Atlantic.

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