(Despite widespread speculation that the turn in the interest rate cycle will burst the housing bubble in the US and elsewhere, precipitating a wider financial and social crisis, early indications are that housing markets will soften and stagnate rather than collapse, according to a report in today’s Financial Times. Analysts say interest rates would have to go a lot higher, and purchasing power decline a lot further for that to happen, even though the gap between house prices and income is at its widest point since the previous housing market boom turned to bust in the late 1980s. This time, the central banks are counting on revived growth -- absent in the late 80s -- to keep enough homeowners solvent and enough homebuyers in the market to cushion the effect of gradually rising rates, allowing the bubble to deflate slowly. Goldman Sachs estimates the US, British, and Australian housing markets are currently overvalued by 10, 15 and 29 percent respectively.) ----------------------------
Will rising rates bring correction or collapse? By Henry Tricks, Virginia Marsh and Christopher Grimes Financial Times July 7 2004 David Salvi set up his estate agency, Hurford Salvi Carr, eight years ago in one of London's property sweet spots: amid the converted warehouses and lofts stretching from the capital's traditional financial district, the City, to its new one, Canary Wharf. In that time, property prices in his area have soared as much as 175 per cent - far more than the national average. Yet most of the increase occurred during the first five years he was in business. Mr Salvi says he has not experienced "boom conditions" since 2000, at the height of the stock market bubble: while there have been minor fluctuations, average home prices in his patch are little changed since just before the September 11, 2001 terrorist attacks in the US. For that reason, Mr Salvi cursed when Mervyn King, governor of the Bank of England, warned last month that the risk of a fall in house prices had increased. "It was overkill. We lost five deals that Monday as a result," he said. In his opinion, the market in which he works had already experienced the "soft landing" that Mr King was trying to engineer. Nationally, however, UK prices were rising at rates of 20 per cent or more a year. Across the western world, homeowners and estate agents such as Mr Salvi are bracing themselves for more of such this sort of central bank intervention as the global interest rate cycle turns, partly in a bid to cool overheated housing markets and excessive borrowing. But in all countries, pockets of blistering hot-house prices sit alongside cooler spots such as Mr Salvi's Docklands. That complicates the task of central bankers trying to engineer a correction without causing a collapse. Evidence so far suggests that housing markets where rates have risen are slowing gently, rather than suffering from panic selling. That is good news for policymakers worried about what a sharp jolt to confidence could do to their over-leveraged economies. Whether this sense of calm persists depends on how high rates are expected to rise. In Australia, two interest rate rises in quick succession last year appear to have cooled house price inflation in Sydney and Melbourne, its two biggest cities. In the UK, the first quarter of the year saw feverish price rises, especially in the less affluent north of England. But after a rise of 100 basis points in interest rates since November, and especially following Mr King's warnings, many estate agents report slackening home sales and falling asking prices. Mortgage lenders have also seen signs of a slowdown in June. The evidence in Britain to say this is the long-awaited correction, however, is still inconclusive - indicators of activity have fluctuated wildly for several years and there have been several false peaks. Most recently, the US's quarter-point rate rise last week to 1.25 per cent was the first in four years. But the expectation of higher rates had led to a flurry of homebuying in the first half of the year to catch the best mortgage deals before borrowing costs rose. In New York, one of the hottest markets, the average price of a Manhattan apartment touched almost $1m this spring. Given the pace of global house price growth recently, few would dispute that properties in many countries are to some extent overvalued. In a recent research paper, Goldman Sachs, the investment bank, warned that the US, UK and Australian housing markets were overvalued by 10, 15 and 29 per cent respectively, after prices had risen by 37, 96 and 82 per cent in real terms since the mid-1990s. It said all three markets were at risk from higher rates. The European Central Bank has not yet raised interest rates in the eurozone, but there too, house prices have rocketed in many countries. Cheap credit has underpinned housing booms in Spain and Ireland, partly because mortgage rates are flexible, and even lacklustre economies such as those of France and Italy saw house price rises above 5 per cent - well in excess of economic growth. Globally, the ratios of house price to income are at their highest levels since the previous housing market boom turned to bust in the late 1980s. But housing market bulls argue that this is not an incontrovertible sell signal. FPD Savills, the UK estate agency, argues that because of low interest rates, the average household still spends less on mortgage payments than it does on transport and travel despite the increase in house prices. Oxford Economic Forecasting, the UK research company, says that the extent of overvaluation in Britain may be between 5 and 15 per cent, depending on which house price index is used; some are affected more by expensive properties than others and have not risen so quickly. For central bankers, the problem is not just which index to look at. There are so many parts of the housing market, from expensive dwellings to dilapidated terraces and tenements, that it is hard to make policy for everyone. Nor are interest rates the smoothest of brake pedals. The sensitivity of housing markets to tighter borrowing conditions depends on the amounts of fixed-rate or floating-rate mortgages, the number of cash buyers, and the preponderance of investors as opposed to owner-occupiers. However, there are common elements. Goldman Sachs points to the recent experience of Australia as a lesson for other markets. "If you want to see what can cause a housing market to turn, we think the best view in the next 12 months will be over Sydney Harbour," it says in its recent report. Yet the signals from Australia are mixed. Some argue that prices have, at worst, fallen slightly rather than turned down sharply, and see this as positive for homeowners. "There is pretty clear evidence of a soft landing," says Robert Mellor, a director at BIS Shrapnel, an economic forecasting agency, in Sydney. "A modest half-point rise is not enough to kill the market off. The typical behaviour of property markets in such situations is that they stagnate." According to the Australian Bureau of Statistics, prices of established (rather than new) housing rose 2.5 per cent in the first three months of the year, their slowest rate of increase in three years. The period was the first quarter since two interest rate rises late last year that saw the official cash rate increase 50 basis points to 5.25 per cent. But Australian Property Monitors, a private sector group, paints a more gloomy picture, finding that prices in Sydney and Melbourne fell 7.5 per cent and 12.9 per cent respectively in March. There is less disagreement over sales activity: agents and buyers both say it has slackened sharply. In particular, there are far fewer buy-to-let investors, especially in New South Wales, the most populous state, which has introduced a 2.25 per cent vendor tax on investment properties. During last year's peak, agents say buyers or sellers of investment properties accounted for 40-45 per cent of market turnover. In Britain 7 per cent of new mortgages went to buy-to-let investors. Looking ahead, the question is whether the Australian market has slowed enough to dissuade the central bank from raising rates again. Economists have been surprised at the continuing strength of housing credit, which rose 20.3 per cent in the year to May, close to a 15-year high. The Reserve Bank of Australia, the central bank, suggested it might act again after the upcoming federal election, expected between August and October. Ian Macfarlane, the RBA governor, last month said that while it was encouraging that loan approvals were down on last year's peak of A$15bn a month, they were still "far too high" at A$12bn a month. A contrast with the housing bust of the 1980s is that this time interest rates are rising not at a time of global recession but at one of expansion. Indicators of financial stress such as loan arrears, as well as unemployment and interest rates, are historically low. In addition, housing markets are underpinned by net population increases, owing to strong migrant inflows, and by the proliferation of property investors seeking an alternative to a lacklustre stock market. "In the last correction, interest rates spiked high and people lost their jobs," says Sam White, deputy chairman of Ray White, one of Australia's biggest estate agents. "This time we're not expecting blood on the streets. Most people can afford to pay their mortgages. It wasn't a recession that ended the boom, it was the Reserve Bank talking the market down." According to Mike Buchanan, economist at Goldman Sachs and author of the recent global housing report, housing markets can be divided into those that are "interest-sensitive" and those that are "income-sensitive". Central London, for example, where prices have broadly stagnated since 2001, is the latter. By FPD Savills' estimates, 60 per cent of the property deals valued at more than £1m have been cash only, which explains why they have regained some fizz this year: a recovering stock market buoyed bonuses and confidence among cash buyers impervious to higher interest rates. Most of the UK market is more rate-sensitive because of high levels of floating-rate mortgage debt. "The fact that interest rates have been so low has been the main driver of growth of the last few years," says Dominic Grace, head of the new homes division of FPD Savills. "It's harder work now than it was three months ago, and Mervyn King's comments have not helped the cause." In the US, where most mortgages are at long-term fixed rates, sensitivity to fluctuating borrowing costs is less pronounced than in the UK and Australia. Nevertheless the strength of activity this year has surprised many. Deanna Kory, an agent with New York's Corcoran Group, says the buying binge that began last autumn was unlike any period she could recall in 19 years. "It was a crazy frenzy, with 20 bids on the table for each property," she says. A New Yorker who waited until spring of this year to buy that "average" Manhattan apartment would have paid 28 per cent more than a year earlier. Mortgage brokers and agents say the New York market remains hot. But there is angst about whether the property boom will have a happy ending, both for New York and the country as a whole. The National Association of Realtors expects US home sales to reach 6.17m this year, a record for the second consecutive year. Average prices for existing, rather than new-build, homes in the US rose 10.3 per cent in May to $183,600, the group says - well above historical annual appreciation rates of 4-5 per cent. Edward Leamer, an economics professor and director of the University of California's Anderson Forecast, says he is concerned that US home prices have reached unsustainable levels. He says economic recoveries usually lead consumers to make purchases deferred during leaner times. Yet US consumers, lured by inexpensive financing, bought automobiles and homes during the recent downturn. "There will be inevitable weakness in cars and homes in the years ahead," he says. Forecasters in the US property industry are more optimistic. Improvement in US job growth will help soften the impact of rising rates, which remain low by historic standards, they say. Lawrence Yun, senior economist for forecasting at the National Association of Realtors, admits that prices in some markets seem "outrageous". But he expects interest rates for 30-year fixed mortgages - the standard in the US - to rise from 6.3 per cent now to about 7.5 per cent next year. "Historically speaking, these mortgage rates are very favourable," he said. "Consequently, we forecast [home prices] to steadily slow - a deceleration as opposed to a decline." That is the hope of many of the world's central bankers, too. The ripple effect on consumer confidence of collapsing housing markets from America to Australia would take a heavy toll on the global economy. The fact that softening prices in cities such as Sydney, Melbourne and London have not yet triggered a property-selling stampede is, so far, good news for such hopes.
