House prices could fall 30%. Should investors be worried about a repeat of 2008?
Some analysts are predicting that house prices could fall as much as 30%, which, when compared to the fact that prices have jumped 28% since April 2019 doesn’t seem too unrealistic. But could this cause another financial crisis?
Analysts expect this trend to continue into 2023, with some predicting that prices could decline by as much as 30% next year (this could be good news for buyers looking to snap up a bargain).
As a general rule, any forecast about any market should be taken with a pinch of salt.
That being said, it’s difficult to argue that UK house prices can repeat their performance of the past two years. Since April 2020, according to the Office for National Statistics, the average house price has jumped 28%, although this does need to be put into context.
If prices fall 30%, the average UK house price will fall back to just under £210,000, the level last seen in 2016.
If prices fall 20%, they’ll be back around the £235,000 region, roughly where they were before the pandemic and the Bank of England’s (BoE) zero interest rate regime. That doesn’t look so outlandish.
Falling house prices aren’t so unrealistic
At MoneyWeek we’ve been arguing for a long time that UK house prices are just as dependent on interest rates as they are on other factors (such as supply and demand). If rates are low, people can borrow a lot more for less, and they’re happy to fork out more for the same home. But if rates rise, and the cost of borrowing jumps, borrowing power declines and people have to settle with less.
The BoE base rate has jumped from 0.1% to 3.5% since November 2021, and this is bound to have an impact on homebuyers’ purchasing power. As a rough comparison, the last time the base rate was this high (2008) the average UK house price was £170,000.
Of course, this is not a direct comparison as there are other factors (such as wage growth) that will have an impact on buyers’ borrowing power. Still, it’s a good illustration of the challenges the market is facing.
The really big question is if UK house prices fall 30%, will it cause a repeat of the 2008 financial crisis?
The simple answer to this question is probably not. The longer answer is that it’s complicated.
Could we see another financial crisis?
A crisis tends to happen because something no one thought possible happens. In reality, no banker or a government official wants to have to sort out one of these messes - so they try and avoid them happening in the first place.
That’s why when a serious crisis emerges out of nowhere, what starts as a seemingly small issue snowballs into a big headache.
That’s what happened with the global financial crisis and the UK government gilt crisis at the end of last year - all parties were caught by surprise as something that wasn’t supposed to happen, started to happen.
In both cases, clever heads at banks and pension funds believed they had done their calculations correctly. They believed the risk was well managed. Unfortunately, these formulas and calculations failed to take into account the extremes. It’s at these edges where the vulnerabilities will always lie.
Back to the present. Based on the data we have today, even if house prices fall 30%, it’s unlikely to be much of an issue for lenders.
According to the ONS, at the end of 2020, there were 8.8m dwellings owned outright and 6.8m owned with a mortgage. Mortgagees are in the minority.
What’s more, Lloyds Bank, one of the country’s largest mortgage lenders, has reported an average loan-to-value (LTV) ratio on its mortgage portfolio of around 40%. That leaves a lot of headroom.
Yes, this is just a snapshot of the situation, but it’s hardly devastating.
House prices could take a hit from higher mortgage rates - what does this mean for you?
One of the biggest issues over the next year is going to be the rolling over of the covid cohort of homebuyers onto higher rates. In 2020, as the housing market boomed, buyers binged on cheap credit, locking in rates of 1% or lower on two-year mortgages.
The best two-year deals on the market today for those with a 60% LTV ratio are in the range of 4.80%. A homeowner with a mortgage of £400,000 will have to pay £2,300 a month at 4.8% compared to £1,500 at 1%.
Some people won’t be able to afford this increase, but lenders are already making it clear that they want to work with borrowers to navigate the current challenges.
In fact, the last thing banks want to be doing is repossessing thousands of houses, which is costly and they may then have to sell these homes at a loss. It’s easier to work out a favourable payment plan with the original borrower.
Spillover effects from falling house prices
The housing market is a huge part of the UK economic ecosystem. Housing accounts for just under £7trn or 38% of the country’s overall wealth, coming second only to private pensions (accounting for more than 40%).
As such, a slowdown in the property market is bound to have an impact on the overall economy. There’s already a chill blowing through the building sector, which could spread to other industries.
Let’s say a housing market slump leads to a collapse in the demand for new carpets causing a major carpet retailer to go into administration. This could put further pressure on commercial property prices - a market that’s already under considerable strain - and spillover into other sectors.
Indeed, Direct Line recently warned that due to falling commercial property prices, its capital ratio had fallen to the lower end of management expectations. As a result, the firm cancelled its final dividend. Other insurers may have the same problem and they might be forced to hike premiums for consumers to cover the gap.
This is one example of how changes in the property market can have widespread effects far beyond house prices and uncover risks analysts and policymakers have not considered before.
So once again, we come back to this question: will a house price crash lead to a repeat of 2008?
If house prices fall 30%, it’s very unlikely lenders will start collapsing, but it’s the other risks investors need to watch out for, those risks that might not be so obvious to begin with.