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It’s very easy to become parochial when it comes to thinking about property markets.
We focus on the slowdown in the UK market and we ponder what’s causing it. Could it be new rules on landlords? Could it be the crackdown on overseas investors? Could it be Brexit?
But this really is less than half the picture.
Because the residential property slowdown isn’t just happening in the UK – it’s happening pretty much everywhere.
Why residential property matters
We talk about property a fair bit in Money Morning. There are a few reasons for that. Firstly, everyone’s obsessed with it. So it’s fair game as a topic.
Secondly, it’s an important asset class. Stockmarket crashes grab headlines, but the truth is the market can slide hard without ever really scratching the sides of the economy. But if the housing market crashes, you tend to know about it, because typically there’s a lot of debt involved.
Thirdly, it’s usually a pretty big item on the household balance sheet. I think it’s fair to say that the majority of us aspire to owning a home and clearing the mortgage. And those who already have might be keen to use it to fund other things – retirement, deposits for offspring, or even an inheritance (although my advice on this latter point is spend the lot, your kids want you to have fun – and if they don’t, they don’t deserve it anyway).
Anyway – so that’s why we go on about property. But as I said in the intro, it’s easy to get a bit too fixated with what’s going on locally. That can lead you to the wrong conclusions. After all, there are a lot of legislative changes that are affecting the UK housing market right now, for example.
But it’s not just the UK. House prices are hitting a wall almost everywhere.
Take Australia. The land down under has long had one of the most expensive property markets in the world. It barely winced during the 2008 financial crisis, despite carnage everywhere else.
And yet now, it finally appears to be losing steam. Prices in Sydney fell by 4.5% in the second quarter, while prices in Melbourne slipped too.
Australia is far from alone. Hot global markets everywhere are slowing down. Canada is another good example.
And now we’re seeing it happen in the US as well. As Bloomberg reports: “The US housing market – particularly in cutthroat areas like Seattle, Silicon Valley and Austin, Texas – appears to be headed for the broadest slowdown in years.”
The number of home sales (of existing homes as opposed to new builds) fell in June for the third month in a row. New builds are selling at the slowest pace in eight months.
Meanwhile, the inventory of unsold homes – the amount of supply on the sidelines – is rising again. Prices in May were up by 6.4% year-on-year (so a lot stronger than in the UK, for example), but that’s the smallest annual gain since 2017 – and over the last three months, prices have risen at their slowest rate since 2012.
What’s interesting about the US housing market is that historically, despite the fact that it bore so much responsibility for the 2008 crash, it has been a relatively well-behaved property market. Over the very long run, US house prices have only risen in line with inflation. You can’t say the same for the UK.
So the fact that it, too, is starting to struggle, suggests that this isn’t purely a bubble market phenomenon.
Why are housing markets around the world slowing down?
Why is this? What do all of these markets have in common? Because clearly, it’s not Brexit. Nor is it cracking down on buy-to-let landlords. And while most countries have grown a little more hostile to foreign investors (most Canadian cities have imposed strict rules, for example), it’s not the most obvious answer.
Let’s go back to basics for a moment. You buy property with debt. Usually a fair chunk of it. Property can be very lucrative as an investment precisely because of this debt (or “leverage”).
Put down £25,000 deposit. Buy a £100,000 house, using a £75,000 mortgage. Sell it in two years’ time for £125,000. Pay the £75,000 back to the bank. Pocket £50,000. The price went up by 25%, but you’ve doubled your money. Rinse and repeat until you’re a millionaire.
But what makes prices go up in the first place? The rational value of a property (as opposed to the “bubble” value) is dependent on the expected rental income it will generate, and what other people are willing to pay for that income stream. It’s just like a bond in many ways, only riskier, and with plumbing involved.
So if you can get 5% from your bank account, you’ll want a lot more from your property – say 10%. But if you can only get 1% from your bank account, you’ll take a lower yield on your property – say 5%.
Let’s assume that the annual rental is £10,000 and it stays there. So with interest rates at 5%, you’ll happily pay £100,000 for that rental income. But with rates at 1%, you’ll happily pay £200,000. (I’m keeping the examples simple here).
You see what’s happened? The price of the property is basically contingent on interest rates.
And what’s happening around the world now? That’s right. Interest rates have stopped going down. And in some cases (notably the US) they are rising. As a result, there’s not much fuel for prices to go higher (rents are as high as they can go without a real boost in wages), and if borrowing costs rise, that will drive prices down.
As Bloomberg notes of the US, affordability is a huge issue in many of these areas, while prices nationwide are still rising “twice as fast as incomes”. Yet the bigger issues is that “buyers are getting squeezed by rising mortgage rates.”
In short, property (alongside bonds) is one of the asset classes that has benefited most from the decline of interest rates in recent decades. And now that’s reversing.
For “normal” people, that has imposed a ceiling on the amount of borrowing they can arrange – they simply can’t afford to buy at the prices sellers still hope to get. For global investors, they’ve realised not only that the world is becoming more hostile to the free flow of footloose capital, but that, quite simply, in a rising rate environment, property is not a good investment.
What happens next? That all depends on rates.
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