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
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