Interest rates

Higher interest rates to test buoyant real estate markets

A combination of high valuations and rising mortgage costs threatens to drive down house prices in several advanced economies, ending a two-year spike in price growth amid historically low interest rates.

After easing the burden on homeowners at the start of the pandemic, central bankers are now tightening monetary policy at a rapid pace to deal with high inflation as a global recession looks increasingly likely, exposing markets to a potential crash. Although experts believe that global house price growth is only likely to slow, they warn that some specific countries will suffer outright declines as their central banks carry out large rate hikes.

In New Zealand, prices have already fallen and some indicators, such as mortgage approvals and applications, show that activity in the United States is starting to stutter.

“Over the past month, there has undoubtedly been a slowdown in buying activity [in the UK]said Mark Harris, managing director of UK mortgage broker SPF Private Clients. “This slowdown is due to rising rates, but also to broader economic concerns: the energy crisis, inflation, the cost of living in general.”

The risk of falling prices is particularly acute in other “Anglo” English-speaking economies such as the United States, Canada and Australia, as well as in Nordic countries such as Sweden, according to Vicky Redwood, senior adviser at Capital Economics. .

“If inflation proves to be even more of a problem, with interest rates in all countries rising much more than currently expected, this could lead to more broad-based house price declines,” he said. said Redwood. It already expects declines of 20% in Canada and New Zealand, 15% in Australia, 10% in Sweden, while house values ​​could drop 5-10% in the UK and the United States.

Markets with a high level of home ownership and the use of variable-rate mortgages were the most prone to price declines, several economists said.

“The higher these two proportions, the greater the pass-through of rate increases,” said Stefano Pica, an economist who has written about the structure of national mortgage markets. “General demand will be affected as mortgage holders exposed to rising rates consume less. This will result in lower property prices over time.

Forced sales are possible in markets where a large proportion of mortgages are subject to variable rates. “If households start to struggle with rising mortgage costs, we could see delinquencies, defaults and [forced] sales,” said Barbara Rismondo, senior vice president of Moody’s, a rating agency.

Adjustable-rate mortgages aren’t the only cause for concern. Some of these markets considered sensitive to price declines have low levels of variable rate mortgages, below 50%, but a large proportion of borrowers who are willing to rollover their fixed rate contracts in the short term.

Unless inflation falls quickly and central banks reverse their monetary tightening, these new contracts will likely be at higher rates. “In many cases, including the UK and New Zealand, the average fixed mortgage term is relatively short, at less than two years,” Redwood said.

Bar chart of average rate on new home loans % showing that mortgage rates on new loans are starting to rise

Unlike the UK and the US, several smaller advanced economies did not experience major corrections in their housing markets after 2008, leaving prices to rise steadily for most of the past 20 years.

Then came the pandemic. Lowest interest rates and other policies aimed at driving up property prices, coupled with the search for bigger homes as the global health crisis forces people to spend more time indoors , boosted the market. According to the OECD real house price index, between the end of 2019 and the third quarter of 2021, house values ​​increased by more than 30% in New Zealand, Australia, Canada and the United States. United States registering increases of about 20%.

Line graph of real house price growth, 2001=100 showing Over the past 20 years, house price growth has been pronounced in small advanced economies

With prices already at high levels relative to incomes, higher rates could depress demand as the cost of taking out a mortgage deters potential buyers.

Five-year fixed rates in Canada were already above 5% – up from 1.9% in January 2021 – before the Bank of Canada announced this week that it was raising rates by 100 basis points.

Phil Soper, managing director of Royal LePage, a major Canadian real estate agent, said higher rates definitely make a difference. “People in Canada don’t buy homes based on their list price, they buy based on their cost of ownership,” he said, referring to the size of mortgage payments. “When those go up, it pushes people out of the market.” However, he added that a tight bid could save the market from an outright price crash.

A global recession, which economists say is an increasingly likely scenario over the winter, would cause further difficulties in the housing market. The biggest risk is that a slowdown will cause unrest in labor markets. “To see a significant fall [in house prices] an explosion of unemployment should occur. . . [forcing people to sell]said Innes McFee, chief economist at Oxford Economics, a research group.

Markets have started to price in the increased risk of a global recession. Large declines were recorded in a range of commodity markets, with investors betting that rising borrowing costs will start to weigh significantly on demand.

A bright spot is the relative health of the financial system. Analysts remain convinced that, having built up stronger capital buffers in the wake of the 2008 financial crisis, the banking system in advanced economies is still able to withstand any significant decline in real estate valuations.

Moody’s research shows that “even with a slight or even steeper decline in house prices, there is no significant risk to the balance sheets of major financial institutions,” Rismondo said.