introduction
Mortgage rates have doubled and tripled in some countries since 2021. So why haven’t the residential real estate markets come under more pressure?
For example, the typical The ratio of house prices to income within the UK is a staggering 9x. This means that almost all borrowers are spending more of their income on interest and principal payments than ever before. The typical UK mortgage lasts five years, however the rate of interest on a brand new loan has risen from 1.8% a yr ago to 4.6% today. Many borrowers cannot refinance at this level and can find yourself in default. The bank will then sell the home, increasing downward pressure on the true estate market.
Nevertheless, the true estate markets proceed to surprise. Many, including this writer, felt that property within the UK was already overpriced over the past decade, with a mean price to income ratio of 6x. Then these houses became even costlier. Perhaps governments will step in and support borrowers as political pressure mounts. Or perhaps inflation will cool and central banks will cut rates of interest.
Because many variables influence real estate prices, valuing residential real estate as an asset class is an advanced undertaking. So what are the important thing drivers of the sector, what are a few of the commonest misperceptions and what’s the long-term outlook?
supply and demand
Housing prices are influenced either by fundamental imbalances between supply and demand or by easy speculation. The former is simple to know: when demand exceeds supply, prices are inclined to rise. Supply might be limited by natural population growth, immigration, urbanization, regulation, or a mix thereof. Trends are inclined to vary from country to city and even inside cities, making it difficult to get a transparent picture of the true state of real estate markets.
When evaluating real estate investments, the excellence between nominal and real post-inflation returns is crucial. For example, residential real estate in China appears to have been a protected bet given the country’s phenomenal economic growth over the past 20 years. While that is true for Shanghai and other cities, property prices in China only increased nominally by 3.5% per yr between 2005 and 2022. This compares to an annual GDP growth rate of 8%. So in real terms, residential real estate may not have been as big an investment because the Chinese economy as an entire.
Nominal and real property price growth often fluctuates
Sources: Bank for International Settlements (BIS) and Finominal
It’s a standard assumption that residential real estate increases in value over time, but that is not all the time the case. When supply and demand in an actual estate market are in balance, prices can remain stable for many years. Germany’s population has only increased barely from 78 million in 1970 to 83 million in 2022, and real property prices have hardly modified over your entire period.
Real estate prices can remain unchanged for many years
Sources: Bank for International Settlements (BIS) and Finominal
Based on fundamental demand, the long-term outlook for residential real estate on the planet’s ten largest economies looks quite bleak. Since population growth is barely expected in 4 of those countries over the following 80 years, a complete population decline of around 600 million people is predicted in all ten countries. Efforts to extend birth rates through more child care services or other population growth incentives have largely failed. Increased immigration may help, but few countries have experience with the mass immigration required, and even people who do often face internal resistance.
Most of the decline is predicted after 2050, but Japan will shrink by around 25 million people by then, in keeping with UN estimates, and is already feeling the consequences. Rapid depopulation has occurred in lots of rural areas, and municipalities are struggling to finance and staff schools, hospitals, and other public infrastructure. Some cities now offer tax breaks for brand spanking new arrivals or just pay people a relocation fee. Either way, there shall be less demand for housing, and that may ultimately mean lower prices.
The demographic outlook is bleak in lots of major economies
Estimating population growth from 2023 to 2100
Sources: United Nations (UN) and Finominal
speculation
Speculation is one other essential driver of real estate prices and is available in many variations. Sometimes prices rise as a result of an imbalance between supply and demand. This encourages investors to speculate their money and creates a positive feedback loop.
In some countries, entire generations have grown up with the concept of the property ladder. In the UK this meant buying a small flat after university, selling it once it had increased in value, buying something barely larger and hopefully over time moving as much as a big house within the country. Of course, this assumes that property prices will rise perpetually.
But as in any financial market, such feedback loops can result in bubbles which might be very painful to interrupt down. As a rising economic power within the Eighties, Japan experienced a big increase in real estate prices within the Eighties, but the next bear market lasted for nearly three many years.
Real estate bear markets could be long and painful
Sources: Bank for International Settlements (BIS) and Finominal
Fiscal and monetary policy may encourage real estate speculation. Following the worldwide financial crisis (GFC), the UK government adopted a Help to Buy scheme offering interest-free mortgages, and quantitative easing (QE) and other accommodative measures from central banks provided strong tailwinds for property prices. Interest rates had been declining in most developed countries because the Eighties, prompting each retail and skilled investors to look to real estate as a substitute for bonds and withdraw trillions of dollars of capital from fixed income securities.
As a result, property returns hit record lows, with UK homes generating lower than 2% a yr in rental income before maintenance costs and taxes. Therefore, residential real estate made little sense as an investment – except in comparison to equally low and even negative bond yields in some European countries.
However, with the rise in rates of interest over the past two years, the pendulum has swung in the opposite direction. Financing home purchases has turn into significantly costlier and with higher returns on the bond market, owning a house as an investment has turn into even less attractive.
The tailwind of falling rates of interest in the true estate sector has disappeared
Source: St. Louis FRED, Bank for International Settlements (BIS) and Finominal
More thoughts
Given the awful outlook for residential real estate, should investors proceed to speculate on this asset class?
It’s difficult to say within the short term. There are just too many variables at work. In housing markets with variable rates of interest, default rates could skyrocket and trigger a full-blown housing crisis. Or not.
Real estate price predictions could be as pointless as stock price predictions. In the long run, countries with greater demographic challenges are probably best avoided, while countries whose populations are expected to grow could also be price exploring. And on this basis, India and Africa stand out, but in addition the nice old USA for less adventurous investors.
Further insights from Nicolas Rabener and the Finominal Team, enroll for her Research reports.
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Photo credit: ©Getty Images / lerbank
