It looks like 2017 could end up being the year of the 'Great Housing Crash'

A buy-to-let bust, lower incomes, Brexit and homeowners failing interest rate stress tests could mean that the bubble is about to burst 

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The Independent Online

Could 2017 be the year when the house price madness ends? Could it even be that there’s a property crash just around the corner? There are reasons to fear (if you happen to be sitting on a large pile of valuable real estate ready to cash in) or to hope (if you’re an aspirational first or second-time buyer) for such a turn of events. For the economy, broadly, it would probably not be a pleasant shock, to add to all the others we’ve been through so far. Often as not, that tends to reinforce the initial weakness in prices, as homeowners who are, or who feel, poorer spend and borrow less, take fewer loans out and, thus, weaken house values still further. That’s why “soft” adjustments can transform into crashes. Good news for first-time buyers, though, and an instant solution to the housing crisis (at least for those who have jobs).

In recent months there has been a bit of a soft landing, with a slowing in both house price inflation and in the volume of transactions. Nothing too alarming yet – the Chancellor’s view that the UK economy has been “resilient” after the EU referendum vote seems well justified – but they could be straws in the wind. Some of the fundamentals that have been propping up the housing market for years, if not decades, are starting to show some signs of fatigue.

Take, for example, the buy-to-let boom, which has lent a bit of a speculative/investment quality to the armlet for residential homes. This was underpinned by substantial tax breaks, (relatively) cheap housing stock (I’m going back a while now) and a healthy demand for rental property. Each of these are going to be weaker over the next few years. The demand for rental property will be affected by the restrictions in migration that will arrive with Brexit, as well as an overall stricter approach to allowing students into Britain to study (though pressure from China and India may alter that). If we are going to have fewer Slovak warehouse workers, Latvian potato pickers and Chinese students looking to rent digs, then the effects on the value of your flat will be obvious.

Remember that buy-to-let investors are seeing stamp duty and taxation on their rental incomes increase, with yields falling with shrinking demand. Unlike families who have to have a roof over their heads, these buy-to-let speculators/investors are ready and rapid sellers when the need arises. A buy-to-let led crash was much talked about in the banking crisis of 2008-10, but never quite materialised. We live in less panicky times now, but there is still the possibility that, when these owners sense the market is about to turn against them, they will cut and run, dumping their portfolios onto the market for a quick sale. That would seriously stymie the whole market, and drain it of that most vital ingredient – confidence. Buy-to-let, in other words, adds instability and is certainly one possible source of a crash that would hit everybody.

The broader fundamentals are not looking good, either. In the very long run, property prices have to bear some relation to the productivity of an economy and the incomes of those who work in it. As the economy slows – and even the most optimistic Brexiteer has to concede that point – there will be fewer jobs, and for those in work there will be stagnating, at best, real wages, with accelerating inflation nibbling away at purchasing power and the funds available to feed a gigantic mortgage. As the euphemism runs, income-to-value ratios are at globally and historically very high levels, and certainly unsustainable (I know that’s been said before, but it doesn’t make it wrong).

It’s true that the collapse in sterling has opened up some opportunistic buying by foreigners who suddenly see the dollar price of prime London real estate drop by 10 or 20 per cent, but that is not going to be sufficient to buoy up a sagging market that is still heavily reliant on the health of the domestic economy, and the confidence that such health creates. Confidence is a fragile commodity, easily fractured by a negative news flow, and 2017 will see some very negative stories indeed, including the adventures of President Trump and almost monthly crises in the EU. It can surely only be matter of time before they extend to the property scene.

It is all-too-obvious that London’s economy has been disconnected from the rest of the UK for some time, for good or ill. For Londoners and those in its commuter dormitories from Berkshire to Suffolk to Brighton, the grim prospects of the City of London post-Brexit will be especially painful. Here, in the financial sector, are the big salaries and bigger bonuses that have fuelled so much of the real estate boom over many decades.

Indeed you could argue that the greatest single factor in the UK’s gross inequalities in wealth and income, especially the North-South divide and the misery of Generation Rent, was the deregulation and subsequent success of the City after the Big Bang reforms of 1986. The housing market has had its ups and downs since, but the one thing that has pumped money into it like adrenaline has been the bankers’ booming bonuses. It would not take much of a reduction in their size and scale as financial firms relocate some operations to Paris or Frankfurt to puncture the market’s bullish mood.

One other factor that has slowed property activity lately is the inability of some buyers to pass an interest rate “stress test”. If you can afford a mortgage rate of 0.5 per cent or 1.5 per cent, you also have to be prepared for a more normal rate of interest – say 5 per cent or 7 per cent. We have become so used to ultra-low rates – Bank of England Base rate has been at 0.5 per cent or lower for almost eight years now – that we’ve forgotten what normality looks like.

There is every reason to expect the next movement in interest rates to be up, for the following reasons. First, inflation is going to come back, and there are limits to which the Bank of England will be able to “look through” an inflationary spike, especially if it starts to feed into wage growth. Second, led by the US Federal Reserve, there is a global trend to lower rates. Third, with rates so close to going negative, the next move is that much more likely to be upwards just because of where rates stand at the moment (though the timing of that turning point is uncertain, and it is theoretically possible for rates to go lower if more cash is injected into the economy).

With higher rates come higher mortgage bills, some immediate, more delayed by two-year deals, but still looming. The rise might not be much – £25 a month for a start – but the damage to sentiment would be disproportionately great. Psychology and herd instinct plays its part in the housing market as elsewhere.

Last, there is the simple fact that housing crashes usually arrive when people least expect – that is, when no-one thinks house prices can ever fall. That psychology has ruled for a long time, and for such a long period that few people believe that the value of their home, or their property investment, could ever fall, or at least by a material amount. Memories of the last proper crash, which ended a quarter of a century ago, have faded. The phrase “negative equity” draws blank stares from millennials. All the talk, indeed, is of the housing shortage and shockingly expensive rentals and price tags.

Like a Ponzi scheme or pyramid selling, the British housing market has defied economic reality and flown ever high on the current of credit and confidence. It will not survive the perfect storm of rising interest rates, stagnant wages, rising unemployment, higher taxation, and lower demand from migration and all the rest of it. So, ask yourself this question: what do you expect the next movement in house prices to be? Up or down?

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