Rising borrowing costs are putting a strain on both property owners and homebuyers around the world.
As central banks hike interest rates at the quickest rate in decades, driving down home prices, purchasers are retreating from the market in cities like Sydney, Stockholm, and Seattle. Millions of Americans who took up low-interest loans to buy houses during the property boom now have higher payments due to loan resets.
A global economic crisis is in danger of getting worse due to the quick cooling off in real estate, a major source of household wealth. While the current downturn hasn’t reached the same heights as the financial crisis of 2008, how it develops will be a crucial factor for central bankers trying to control inflation without harming consumer confidence and starting a severe recession.
Hideaki Hirata of Hosei University, a former Bank of Japan economist who co-authored a report on global house prices, predicted that the housing industry will experience a decline in 2023 and 2024. He cautions that it would take some time for homes to feel the full effects of this year’s dramatic rate increases.
He claimed that “sellers frequently ignore indicators of declining demand.”
Real Estate Slump
Cities that experienced the largest increases in home prices are now seeing dramatic drops.
Economies are impacted by higher real estate financing costs in a variety of ways. As growing mortgage payments deter would-be purchasers from joining the market, households with loans tighten their budgets, which has a negative impact on real estate prices and development.
The downturn is a sharp contrast to the boom that was encouraged by central banks’ easy-money policies in the years following the financial crisis and then accelerated by a pandemic that made people look for larger spaces and residences that were conducive to remote work. Many homeowners who bought homes at record prices now have loans that will reset higher when inflation soars and there is a chance of a recession.
Rob Subbaraman, head of global markets research at Nomura Holdings Inc., stated that young families who have taken on debt have never encountered a sharp increase in interest rates at a time when their real, inflation-adjusted wages are declining. “They might be rather shocked by this,” I said.
Each nation has a different level of exposure to rate increases for borrowers. For instance, in the US, the majority of buyers rely on fixed-rate mortgages for up to 30 years. Over the previous five years, conventional loans made up, on average, 7% of all loans. In contrast, loans in other countries are sometimes fixed for only a year or have variable-rate mortgages that closely follow government interest rates.
According to a May analysis from Fitch Ratings, the countries with the biggest concentration of variable-rate loans as a percentage of new originations in 2020 were Australia, Spain, the United Kingdom, and Canada.
Vulnerability at a Rate
Many mortgages in other nations are slated to reset soon. For example, in New Zealand, around 55% of the outstanding value of residential mortgages are either on variable rates or fixed rates that need to be renewed in the year leading up to July 2023.
One of the poster children for the pandemic housing boom and its unwinding is New Zealand, where prices increased by about 30% in 2021 alone. According to the Real Estate Institute of New Zealand, house prices were down 11% in July from their peak in November of last year despite seven rate increases by the central bank in the previous 10 months. According to economists, this might eventually result in a 20% decline.
Femke Burger, a 33-year-old insurance case manager, paid NZ$825,000 ($504,000) for a home in the Wellington area in March 2021. According to websites that assess homes, the value of her property soared to NZ$1 million in the months that followed. Those advantages have vanished. Her two-bedroom, semi-detached home is currently worth roughly what she paid for it.
Burger, whose mortgage must be refinanced within the next 12 months, said: “I absolutely feel as though there has been a loss in my own personal financial wellbeing.” It will sting even if she is sure she can withstand the rise in interest rates.
Like the majority of industrialized countries, New Zealand has so far managed to survive the housing recession. A cascade of defaults is unlikely since household balance sheets and savings are robust, job markets are booming, and lending standards have tightened since the mid-2000s boom that precipitated the financial crisis.
Many homeowners still have a sizable amount of equity in their homes after years of price increases, and in some overheated markets, decreased values would make it possible for buyers to enter the market.
According to Kwan Ok Lee, a housing expert at the National University of Singapore, “given that the housing affordability situation is so significant in many major nations, cooling home prices may result in some positive consequences.”
But economists are still uneasy. A sluggish global economy that the International Monetary Fund has warned is on the verge of recession could be affected if the paper losses incurred by homeowners like Burger translate into more substantial decreases for consumers, banks, and developers.
According to Niraj Shah of Bloomberg Economics, “if central banks tighten too much, the probability of a soft landing lessens.” “House prices could decline more quickly, escalating and lengthening a recession.”
Governments in certain nations have already stepped in to assist struggling consumers who are facing quickly rising repayments. Policymakers in South Korea, one of the first economies in the Asia-Pacific to start raising interest rates, recently decided to spend more than 400 billion won ($290 million) to help lower the proportion of families with variable-rate mortgages.
In Poland, where some borrowers’ monthly payments have doubled as interest rates have increased, the government intervened earlier this year to permit Poles to postpone payments for up to eight months. After the industry was required to record roughly 13 billion zloty ($2.78 billion) in provisions, the move eliminated profits for big banks.
China is coping with a growing real estate crisis brought on by a wave of developer bankruptcies and borrowers refusing to make mortgage payments on unfinished properties. The reverberations are beginning to spread to other nations as well.
Home prices in Sweden, once one of Europe’s hottest markets, have dropped by approximately 8% since the spring, and most experts now anticipate a 15% decline. Additionally, when interest rates rise, property companies are under pressure to refinance the significant amounts of debt they took out on the bond markets to fund their operations.
In the UK, price drops are also quickening. According to a Bloomberg analysis, home values are stagnant or declining in over half of the boroughs of London. The UK is on the “cusp of a housing collapse,” according to HSBC Holdings Plc, and demand is expected to fall 20% during the ensuing year.
In the upcoming year, almost 1.8 million UK debtors must refinance. The first-time purchasers who purchased properties as prices rose during a stamp duty tax holiday that was instituted in summer 2020 to support the market during the pandemic are most at risk. A time when real wages are declining at a record rate and the cost of living is rising means that those who fixed for the short term will have to make much greater repayments.
Despite the lower danger of mortgage resets in the US, recent increases in borrowing costs have forced price-constrained buyers into more flexible agreements with lower interest rates. According to data from Zillow Group Inc., the proportion of adjustable-rate mortgages in loan applications increased in July to the highest level in 15 years.
Although there are already indications of more pronounced drops in some places, Goldman Sachs Group Inc. forecasts a flattening of US national prices in 2023. While homebuilders struggle with an overabundance of inventory they can’t sell, sellers are reducing prices in pandemic boom zones that lured remote workers and had some of the largest rises in recent years.
Prepared to Suffer
Economists predict a significant squeeze in Australia and Canada, two of the world’s busiest markets.
Widespread defaults are unlikely because most Canadian borrowers must pass a stress test before being approved for a mortgage, but an economic slowdown that might be felt nationwide seems increasingly plausible. When the nation’s real estate boom peaked earlier this year, roughly 60% of all new mortgages were variable-rate mortgages.
According to National Bank of Canada data, of the roughly half a trillion Canadian dollars in outstanding variable mortgage debt, about a third have had their monthly payments increase in step with the central bank’s benchmark rate. According to the study, these rising interest rates could cumulatively subtract 0.65% from Canadians’ total disposable income over the next three years when combined with the renewal of items like lines of credit and fixed-rate mortgages.
Robert Kavcic, an economist at the Bank of Montreal, stated that “we run the risk of seeing a major downturn in spending activity.” Although we haven’t officially predicted one, we’re getting close.
Australia, where property values experienced their greatest monthly decrease in nearly four decades in August, may be the country where the alarm bells are sounding the loudest. While wealthy households have so far resisted interest rate increases, a crisis point will arise in 2019 as billions in mortgage loans with historically low interest rates are due for refinancing. In Australia, fixed-term loans typically have terms of two to three years, which is a rather short time frame.