IS THE HOUSING MARKET GOING TO CRASH?

IS THE HOUSING MARKET GOING TO CRASH?

by Fatine Hammoussi, November 11, 2022

During the past few years, the housing market was hot, indeed low interest rates have been a significant driver of house price growth. Now the situation is changing because inflation increased more than expected. Indeed, a hard landing, meaning fighting the inflation surge by destroying demand and therefore causing a recession, was and is necessary, but the housing market is showing signs of weaknesses after the rate hikes done. The link between inflation, interest rates and the housing market is not immediate.

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Because inflation is increasing, both corporate margins and the real purchasing power of the citizen are shrinking. There is already evidence that inflation is eating so much of the purchasing power that people in the United States are starting to spend their savings just to keep up with the price increases. Moreover, according to what was stated during the Q2 earning calls of Visa and Mastercard, the country is experiencing a surge in credit card usage, suggesting that inflation is being so damaging for households, that they need to borrow money just to survive. Indeed, the spending statistics point out that most households are cutting all unnecessary expenses outside energy and food, which ironically are the things that are inflating the most.

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Therefore, since people are becoming poorer, the demand for goods and services is slowing, which means that the corporate profits are declining. When corporate profits decline, the first expense to be cut is wages, and indeed every recession is characterized by mass layoffs.

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This leads finally to what’s happening in the housing market. Investing in the housing market has always been one of the safest ways to profit on the long term, because everybody needs a roof, and the supply of homes is limited. However, this market has two important characteristics: 1) high leverage 2) most owners rent their houses as a form of income. As I said earlier, higher rates imply lower present value of an investment, and indeed the average price of houses in the United States is falling, according to the indices published by Redfin: this represents a problem for all the companies and individuals that borrowed against the value of their real estate, as this decline obliges them either to post more collateral or to sell the property. However, with lower demand and people losing jobs, there are not many acquirers at the inflated prices which we were used to see until some months ago. The other problem is that with the real purchasing power in free-fall, and layoffs spreading across the country, many are starting to face difficulties in paying their rent: this translates to either no more income for the landlord, or lower occupancy rate. Considering the attractiveness of real estate depends also on the occupancy rate of the district and/or neighborhood, this further devalues the properties.

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Central banks are issuing warnings of their own about the topic. The bank of Canada stated in its annual review of the financial system that high levels of mortgage debt are of particular concern as interest rates rise and more borrowers are strained to pay bills. The Reserve bank of New Zealand’s semi-annual financial stability report said that the overall threat to the financial system is limited, but a “sharp” decline in house prices is possible, which could reduce significantly wealth and lead to a contraction in consumer spending.

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Some people are comparing this crisis to the one of 2008, but the latter was mainly due to excess speculation of the financial sector, while the current one is due to the controlled demolition of the economy to fight inflation. Furthermore, while in 2008 the banking sector was in a bad shape, at least stability-wise, this cannot be said for today’s banks, which seem to have learned the lesson. However, it could be argued that the start of another big crisis is happening.

Fatine Hammoussi