Higher interest rates to test buoyant housing markets

A combination of high valuations and rising mortgage costs threatens to drag house prices down in several advanced economies, ending a two-year surge in price growth on the back of record-low interest rates.

After easing the burden on homeowners at the start of the pandemic, central bankers are now tightening monetary policy at a fast pace to cope with high inflation while a global recession is looking increasingly likely — exposing markets to a potential crash. Though experts think that global growth in house prices is only likely to slow, they warn that some specific countries will suffer outright falls as their central banks make big rate rises.

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

“Over the last month, there has undoubtedly been a slowdown in purchase activity [in the UK],” said Mark Harris, chief executive of UK mortgage broker SPF Private Clients. “That slowdown is down to rising rates, but also wider economic concerns: the energy crisis, inflation, the cost of living generally.”

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

“If inflation turns out to be even more of a problem, with interest rates across all countries rising much further than is currently expected, then that could cause more widespread house price falls,” Redwood said. She is already expecting falls of 20 per cent in Canada and New Zealand, 15 per cent in Australia, 10 per cent in Sweden, while home values could fall by 5-10 per cent in the UK and US.

Markets with a high level of home ownership and use of adjustable rate mortgages were most prone to price falls, several economists said.

“The higher both these proportions are, the greater the pass-through of rate increases,” said Stefano Pica, an economist who has written on the structure of national mortgage markets. “There will be a hit to general demand as mortgage holders exposed to rising rates consume less. This will feed through to lower house prices eventually.”

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, then we could see some delinquencies, defaults and [forced] sales,” said Barbara Rismondo, senior vice-president at Moody’s, a rating agency.

Adjustable-rate mortgages are not the only source of concern. Some of those markets seen as susceptible to price falls have low levels of variable-rate mortgages, at below 50 per cent, but a large proportion of borrowers who are set to renew their fixed-rate contracts in the near term.

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

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

Then came the pandemic. Rock-bottom interest rates and other policies to boost house prices, coupled with a search for bigger homes as the global health crisis forced people to spend more time indoors, supercharged the market. According to the OECD’s real house price index, between the end of 2019 and the third quarter of 2021, home values increased by more than 30 per cent in New Zealand, with Australia, Canada and the US recording increases of about 20 per cent.

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

Five-year fixed rates in Canada were already beyond 5 per cent — up from 1.9 per cent in January 2021 — before the Bank of Canada’s announcement this week that it was hiking rates by 100 basis points.

Phil Soper, chief executive of Royal LePage, a large Canadian estate agent, said higher rates were definitely making a difference. “People in Canada don’t purchase homes based on their sticker price, they buy based on their carrying cost,” he said, referring to the size of mortgage payments. “When these rise it pushes people out of the market.” However, he added that tight supply could save the market from outright price falls.

A global recession, which economists believe is an increasingly likely scenario over the winter, would lead to more pain in the housing market. The biggest risk is that a slowdown leads to troubles in labour markets. “To see a significant fall [in house prices] a burst of unemployment would need to 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. Broad declines have been recorded in a range of commodity markets as investors bet that higher borrowing costs will start weighing significantly on demand.

One bright spot is the relative health of the financial system. Analysts remain confident that, having built up stronger capital buffers following the financial crisis in 2008, the banking system in advanced economies remains capable of weathering any significant fall in home valuations.

Research by Moody’s shows that “even in case of a mild or even more pronounced house price decline there is no significant risk to the balance sheets of major financial institutions”, said Rismondo.