As the mar­ket heats up, is an­other hous­ing crash likely?

Lon­don and San Fran­cisco’s house prices have raised fears of an­other boom-bust cy­cle, but how close is a mar­ket crash? Tim Wal­lace and Is­abelle Fraser re­port

The Sunday Telegraph - Money & Business - - Front page -

Mc­man­sions are back. Rich Amer­i­cans are splurg­ing on su­per­sized homes with enough gold leaf and chan­de­liers to make Don­ald Trump proud. It is a decade since these vast piles be­came icons of the ex­cesses of the boom years which led to the hous­ing crash – and the fi­nan­cial cri­sis which fol­lowed. Bri­tain too is see­ing some warn­ing signs which ner­vous prop­erty watch­ers, scarred by the credit crunch, fear could be har­bin­gers of doom in the mar­ket.

Look at cen­tral Lon­don. The very top end of the scale, favoured by oli­garchs and for­eign in­vestors as a safe haven, looks less sta­ble. More than half of the top-end prop­er­ties put on the mar­ket so far this year have been pulled as own­ers are re­luc­tant to take a hit on the sale. Over Lon­don’s mar­ket as a whole, price growth has slumped. Ten years on from the last bust, are we on the brink of an­other crunch?

One way to an­swer that ques­tion is to look at the causes of the pre­vi­ous slide in prices and com­pare them to to­day’s con­di­tions. Prices in the UK have risen sub­stan­tially since the pre­vi­ous boom – the av­er­age prop­erty in June cost £223,257, ac­cord­ing to the Of­fice for Na­tional Sta­tis­tics (ONS). That is 17.5pc higher than the level at the peak of the mar­ket in 2007.

How­ever, the pace of change is im­por­tant too. Prices were rel­a­tively flat from 2009 to 2013, then ac­cel­er­ated, ris­ing 29pc in the past four years. That growth is not a mil­lion miles from the 10pc boom the year be­fore the slump.

By con­trast, av­er­age house prices in the US, ac­cord­ing to S&P’S Case-shiller in­dex, passed the pre-crash peak just last Novem­ber, and are just 2pc above the peak at $200,000 (£155,800).

If an over­heat­ing, un­af­ford­able mar­ket is the prob­lem, one can find those in Lon­don or US hotspots such as San Fran­cisco. In May, me­dian house prices in the bay area soared past $1.5m, ac­cord­ing to a re­port from Paragon Real Es­tate Group, and now even tech work­ers are be­ing priced out of the area.

Com­pared to June 2007 prices in Lon­don are up 68pc, and the nearby South East has risen 38pc.

But one char­ac­ter­is­tic of the early years of the 21st cen­tury was the na­tion­wide ex­tent of the bub­ble. That has not been re­peated this time around.

Prices in North­ern Ire­land are still more than 70pc be­low their peak 2007 lev­els, but in line with prices at the start of 2006, un­der­lin­ing the ex­tra­or­di­nary bub­ble in that mar­ket which ex­ploded and then col­lapsed over an 18-month pe­riod. The North East of Eng­land fol­lowed a less ex­treme path, but prices re­main around 5pc down on the decade. In the United States, this re­cov­ery is far more con­cen­trated to eco­nomic pow­er­houses, and any mar­kets re­sem­bling bub­ble ter­ri­tory re­main lo­cal. Run­ning counter to S&P’S in­dex, prop­erty por­tal Tru­lia found two thirds of homes are worth less now than be­fore the crash. Me­dian house prices are $78,000 be­low their pre-re­ces­sion peak, with cheaper ar­eas at the tail end of the re­cov­ery.

Post-crash price growth has been far slower than in the UK, and also far more un­even and frag­mented.

“One hall­mark of the ‘most re­cov­ered’ ar­eas is that they did not ‘bust’ very much in the down­turn, if at all, with val­ues propped up by rel­a­tively solid job mar­kets dur­ing the re­ces­sion,” says Keith Gumbinger, vice pres­i­dent of HSH, a mort­gage tracker.

En­gines of eco­nomic growth on the West Coast, as well as big cities in Texas, have seen huge house price growth in the last 10 years. In ar­eas hit by the ubiq­ui­tous fore­clo­sures of the crash, such as Las Ve­gas, less than 5pc of homes have re­cov­ered the losses made in the cri­sis years.

“In boom­ing cities like Den­ver the me­dian home value is now 57pc higher than dur­ing the bub­ble while in Las Ve­gas, which was hit par­tic­u­larly hard dur­ing the bust, home val­ues are still 25pc be­low their bub­ble peak,” says Aaron Ter­razas, a se­nior econ­o­mist at Zil­low, a prop­erty por­tal.

The last two years have also seen a surge of young adults driv­ing the hous­ing mar­ket, fu­elled by low in­ter­est rates and high lev­els of em­ploy­ment.

For them, as in the UK, af­ford­abil­ity is the issue. This is par­tic­u­larly a prob­lem in Lon­don and its com­muter belt, but in few other ar­eas of the UK. First­time buyer numbers are grow­ing more than twice as fast in Scot­land, Wales and North­ern Ire­land as they are in Lon­don, ac­cord­ing to UK Fi­nance.

The av­er­age mort­gage taken out in the cap­i­tal in the sec­ond quar­ter was £338,900, while those in Scot­land bor­rowed £133,000.

When debts reach Lon­don’s lev­els it can be hard for house­holds to stretch any fur­ther, tak­ing some of the wind out of the sails of the mar­ket – par­tic­u­larly if wage growth is lim­ited.

But that is not the same as a crunch in the mar­ket. A pause in an ex­pen­sive sec­tor might dis­ap­point own­ers who wanted gal­lop­ing price rises to con­tinue, but it also gives breath­ing room for would-be first-time buy­ers to save up for a de­posit or get a pay rise.

There are par­al­lels here with the US. Far more than the UK, there are sets of lo­calised mar­kets, and it is dif­fi­cult to make coun­try-wide gen­er­al­i­sa­tions. But the east and west coasts, with high- pow­ered eco­nomic cen­tres in be­tween, have pushed af­ford­abil­ity to its lim­its.

Both coun­tries also have an issue of sup­ply. While in the UK, the Royal In­sti­tu­tion of Char­tered Sur­vey­ors has said that the sup­ply of prop­erty on the mar­ket is at the low­est rate on record, this is mir­rored in the US. Here sup­ply is low, and ex­ac­er­bated in many ar­eas due to low house build­ing lev­els. These met­rics have not re­cov­ered since the crash, and sit 30-40pc be­hind the lon­grun av­er­age, says Ralph Mclaugh­lin, chief econ­o­mist at Tru­lia: “This sup­ply cri­sis could po­ten­tially lead to an af­ford­abil­ity cri­sis in some mar­kets.”

Regional dis­par­ity is at play here too: this year, Dal­las, Houston and Austin are on course to build 10pc of all homes in the US, equal to 130,000 new prop­er­ties. Con­trast that with San Fran­cisco, which is on track to build just 4,500 homes this year, and where prices rose so high, so fast that they are slow­ing purely be­cause few buy­ers re­main with suf­fi­ciently deep pock­ets.

“New home con­struc­tion has been slower to re­spond as builders re­main re­luc­tant to dra­mat­i­cally ramp up sup­ply de­spite obvious strong de­mand,” adds Zil­low’s Ter­razas. “Cost pres­sures – no­tably from land, labour and raw ma­te­ri­als such as lum­ber – are weigh­ing on builders’ ca­pac­ity.”

While the UK’S econ­omy has slowed, un­em­ploy­ment is still fall­ing, mean­ing house­holds should be in a steady fi­nan­cial po­si­tion.

The fi­nan­cial cri­sis came with a sub­stan­tial rise in un­em­ploy­ment, and the re­ces­sion of the early 1990s was ac­com­pa­nied with a par­tic­u­larly brutal surge in job losses, forc­ing own­ers out of their homes. Such a shock has not yet come to pass, and econ­o­mists do not an­tic­i­pate it hap­pen­ing now.

The con­sen­sus fore­cast is for un­em­ploy­ment to creep up from 4.4pc now to 4.8pc by the end of next year, still a low level by his­toric stan­dards. Typ­i­cal shocks in the past have come in the form of higher in­ter­est rates, and that too does not seem likely to strike any time soon. Econ­o­mists do not ex­pect any Bank of Eng­land base rate rise un­til at least 2019. Over the much longer term as – or if – in­ter­est rates re­turn to more “nor­mal” lev­els, then it could grad­u­ally de­flate the hous­ing mar­ket.

“The fall in UK real mort­gage rates since the late 1980s has essen­tially been off­set by higher house prices such that af­ford­abil­ity [in terms of monthly re­pay­ments rel­a­tive to earn­ings] is cur­rently ex­actly in line with its long-run av­er­age,” says Ge­orge Buck­ley, chief UK econ­o­mist at No­mura.

If monthly mort­gage pay­ments go up, that will weigh on prices. In his model, the base rate rises steadily and grad­u­ally to 4pc in 2030 while real wages also rise by 0.75pc per year.

For home af­ford­abil­ity to stay the same, in line with re­cent ex­pe­ri­ence, this im­plies prices ef­fec­tively stay­ing flat in cash terms over the next 13 years – avoid­ing a crash, but also fail­ing to grow house­hold wealth.

One po­ten­tial threat to the US mar­ket is the dis­man­tling of the Doddfrank Act, cre­ated in the wake of the fi­nan­cial cri­sis, and part of which forced banks to re­tain part of the mort­gages they signed up to en­cour­age more re­spon­si­ble lend­ing. Pres­i­dent Trump has sig­nalled that he wants to pull it apart.

While this wouldn’t lead to an­other it­er­a­tion of the pre­vi­ous crash, it could have dif­fer­ent but per­ni­cious ef­fects on the mar­ket. “The rea­son why that isn’t nec­es­sar­ily what the US needs is be­cause we have a sup­ply prob­lem not a de­mand prob­lem,” says Mclaugh­lin. “Loos­en­ing lend­ing would spur de­mand. That wouldn’t nec­es­sar­ily be good if sup­ply is low, es­pe­cially of af­ford­able homes; it would bump up house prices.”

Bri­tain’s reg­u­la­tors have also tight­ened up lend­ing stan­dards. The mort­gage mar­ket re­view led to tougher af­ford­abil­ity tests be­ing ap­plied to bor­row­ers, in a bid to en­sure buy­ers can cope with a rise in in­ter­est rates. And the Bank of Eng­land has lim­ited the pro­por­tion of loans which banks can give above 4.5 times a per­son’s in­come.

On both sides of the At­lantic there is cau­tion, with noth­ing like the fear of 2007. But mea­sures put in place since the crash have not yet re­ally been put to the test.

We could be see­ing a gen­tle test­ing of the mar­ket’s sta­bil­ity and its abil­ity to cope with regional pres­sures, rather than any na­tional or global boom and bust cy­cle.

“There aren’t any overt signs that a na­tional bub­ble is in the works,” says Gumbinger.

“The rea­son we saw prices fall as we did in the fi­nan­cial cri­sis was be­cause mort­gage lend­ing was at the epi­cen­tre. That is a rare oc­cur­rence,” says Mclaugh­lin.

“The next re­ces­sion we will go through will not likely be caused by the hous­ing mar­ket, but rather for geopo­lit­i­cal rea­sons or some other in­dus­try that is re­heat­ing. Prop­erty prices may flat-line or fall but cer­tainly not to the same ex­tent as they did 10 years ago.”

‘New home con­struc­tion has been slower to re­spond as builders re­main re­luc­tant to dra­mat­i­cally ramp up sup­ply’

‘The next re­ces­sion will not likely be caused by the hous­ing mar­ket but rather for geopo­lit­i­cal rea­sons’

Low in­ter­est rates have made mort­gages less costly for home buy­ers, but af­ford­abil­ity is­sues are mak­ing life dif­fi­cult for many house hunters. In San Fran­cisco, above, even wealthy tech work­ers are be­ing priced out of the city

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