In any economic downturn, there is an underlying concern surrounding housing markets.
This concern is again relevant following a sharp rise in global interest rates, leading many to be wary of the health of residential markets, especially after a two-year period of historic house price rises. But whilst house prices in some countries have dipped, the reality is more nuanced, and residential markets have proved to be resilient. This leads to the question: why?
OCED aggregate nominal house price change
Source:Savills Research using OECD
Foundational economics tells us that price is determined through the interaction of demand and supply. As mortgage rates have risen, demand for housing has indeed dropped. But there has also been a corresponding reduction in the cyclical supply, or number of properties available for sale, providing some balance to markets. Many homeowners have locked in substantially lower rates on existing mortgages, and are thus unwilling to move house and give up these rates. In the US for example, around 95% of homeowners are on a long term fixed mortgage, with an average interest rate of 3.5%, well below the prevailing rate of 7.5% for new mortgages.
Housing transactions across US, UK, China (Tier 1 cities), South Korea, and Australia
Source:Savills Research using Macrobond
Furthermore, there has not yet been a mass of forced sales which would put downward pressure on prices. Household balance sheets are relatively healthy due to excess savings. During Covid-19, many households were able to save due to reduced recreational spending, stipends from governments, and pauses on loan repayments. Apart from the US, households have not spent these savings yet, which can act as a buffer against rising debt service costs.
Tight labour markets – the double-edged sword of the global economy – have also played their part in ensuring that there has not been a significant rise in forced sales. Unemployment rates have remained at or below pre-Covid averages. As of August this year, the US had a unemployment rate of 3.8%, South Korea 2.4%, and Australia 3.7%; each below their respective pre-Covid average. As a consequence, many households can continue servicing their monthly mortgage payments. According to the Bank of Korea, in South Korea only 0.3% of mortgages are delinquent – up from an all-time low of 0.2% through 2021 to 2022 but still much lower than the two-decade high of 1.9%.
Tight supply also helps to explain the resilience seen in pricing to date, due to not only cyclical factors but also structural factors. Strict zoning laws and high construction costs are just some of the factors which have limited residential construction over the past decades. In Canada, the Canada Mortgage and Housing Corporation has said that 3.5 million homes need to be built by 2030; at current rates, only 2.3 million additional homes will be built in this period. This fundamental issue of low structural housing supply has the potential to be exasperated even further given the rising cost of construction.
Looking towards the future, the good news is that central banks appear to be largely done with rate hikes. Reduced transactions, excess household savings, and tight labour markets have all helped prevent volatility in house prices, but these factors can quickly reverse.
The current message from the major central banks is that rates will need to remain “higher for longer”; in economies such as the UK, where mortgages are often a fixed rate for two to five years, this may simply delay the impact on higher mortgage rates. Nearly 1.4 million mortgages will come to the end of their fixed rate period this year, and an additional 1.2 million will end in 2024. In Sweden, where less than 20% of mortgages are fixed, house prices have already dropped by 12% since their peak in March 2022. As more households move off existing fixed rate mortgages, affordability will be further squeezed, reinforcing any downward pressure on prices.
Whilst much of the concern regarding mainstream residential markets revolves around mortgages, one key difference between prime and mainstream buyers is the number of cash buyers. With increasing interest rates, the prime residential market’s reliance on cash is advantageous. This helps to explain why mainstream house prices have slightly dropped or plateaued in some locations, whereas prime prices have increased. According to Savills World City Prime Residential Index, capital values across 30 global cities continued to appreciate in the first six months of 2023, rising by 1.1% – exceeding expectations.
Uncertainty in the sales markets has served to boost rental markets across the globe. Prime rents grew by 2.6% across 30 global cities in the first half of 2023. This trend is also evident in mainstream markets; Sydney has seen rents increase almost 20% year-on-year according to the New South Wales Department of Communities & Justice. For both prime and mainstream markets, prospective purchasers choose to rent instead amidst limited supply.
Despite economic uncertainty, global housing markets have fared surprisingly well due to low cyclical and structural supply, excess household savings, and tight labour markets. The storm isn’t over yet however. The combination of higher monthly mortgage payments, dwindling excess savings, and ‘sticky’ inflation, means that some households may suffer from stretched affordability and struggle to meet their monthly mortgage payments. Labour markets are beginning to turn and unemployment rates have risen from recent lows. But whilst global markets face significant economic headwinds, housing markets have, so far, proven resilient.
