So the big question is what lies ahead for the property market when the economy inevitably turns?
- Will house prices continue to rise?
- The probability of future increases in house prices is extremely low. With borrowers reaching their financial limits they are unable take on significantly more debt while their salaries rise only slowly. Even if more money was made available to them, they would not be able to afford the repayments out of their monthly salaries.
Therefore a very definite cap on house prices is in place.
- Will house prices plateau over a number of years until equilibrium is restored?
- Possibly. Historically this has never occurred following such significant price rises over an extended period. It is however possible, as long as the global economy remains in good health. But we all now know that the economy is cyclical and that a downturn will come, even if we cannot anticipate exactly when.
Given the meteoric price rises over the last decade, and the extremely high level of indebtedness of homeowners and the consumer in general, it will not take much of a downturn to cause panic in the banking sector and for lending to dry up. As a result, should the economy show ANY signs of weakness over the medium-term, the probability of falling house prices becomes far higher than the probability a stable plateau being maintained. Is this a chance you are willing to take?
- Will there be a house price crash?
- Two simple things can occur which, either separately or together, will result in a house price crash. Problems will begin to arise as soon as the health of the economy starts to decline.
i) End of Low Cost Borrowing
In a weakening economy, businesses including banks and other mortgage lenders will change their orientation from expansion to conservation. They will seek to minimise risk and to focus on higher quality business. As consumers begin to default on their debts the banks and other lenders will seek to lend much smaller amounts and to only the most secure customers. Expect an end to 0% credit cards and other similar teaser products.
The result of the above, is that the average indebted consumer will be forced to pay back their credit card and loan balances or end up paying interest on them at 20-30% APR. The impact on consumers’ bank accounts and disposable income will be significant enough to change the orientation of the public from consumer to saver, removing almost all of the desire and the ability to over-borrow on mortgages. This in turn will lead to price weakness in the housing market.
ii) A Return to Traditional Lending Practices
As the economy begins to suffer the supply of money will contract. An exponential increase in money supply in recent years will most likely give rise to a similarly marked decrease as conditions worsen. Banks will be forced to curb lending and the credit they create will evaporate. By cutting lending back to more traditional lending multiples, they will remove a significant proportion of the borrowing power available to homebuyers. We will revert to the position where an average couple need a £92,798 deposit at 2.5 times average salary. And if homebuyers can’t pay as much for the houses they want, the value of houses must drop to meet the level of funding available to buyers. As a result the market will dislocate and crash, possibly overnight.