As inflation rates rise and a global recession looms, people are left asking whether we could be heading for a 2008-style housing market crash.
Before we get into a housing market crash and its impact, it’s important to understand the step that comes before that – a housing market bubble.
What is a housing market bubble?
A housing market bubble is a period of high demand for properties and low supply, which pushes the prices beyond the intrinsic value of the homes. The bubble often coincides with economic growth, lower interest rates and easy access to mortgage products.
When the housing market is growing, individuals tend to have more disposable income that they’re willing to spend on other services – such as home improvements, furniture and white goods. Employment rates are also usually higher, as the demand for housing boosts the number of new start developments, which requires a greater amount of labour from the construction industry.
While a boost in home prices and ownership itself doesn’t indicate a bubble exists, it forms the basis of the mentality that the increasing growth will go on forever. And it’s this unbridled optimism that creates a speculative bubble that eventually leads to a real estate market crash.
Learn more about bubbles
What is a housing market crash?
A housing market crash is a significant and sustained fall in the value of properties, usually after a prolonged period of exuberance and high demand. It’s a result of the prices of houses rising to such high values that buyers are unwilling to support the market any longer.
We tend to accept that buying and selling other asset classes – like stocks, forex and commodities – comes with significant risk. But we don’t often consider that house prices depend on supply and demand too, and that buyers might not always be able to sell a property for more than (or even the same price) they bought it for.
But like all markets, house prices go through periods of boom and bust. Admittedly, housing market crashes are historically less frequent than other types of market crashes, but they do tend to have ripple effects into financial markets that can cause downturns in other assets.
Learn about stock market crashes.
When interest rates rise, and mortgages become less affordable, the disposable income individuals relied upon disappears. They may be unable to pay their monthly costs, and be forced to sell or have their homes repossessed.
A housing market crash is also likely to cause a surge in unemployment, as the construction industry no longer experiences the same level of demand and lays off staff.
When was the last housing market crash?
The last UK housing market crash was in 2008, when the country went into a recession. This was caused by deregulation in the financial industry.
It was also brought on by the housing crisis in the US, where banks were lending to people who were unable to pay their mortgage. Then almost overnight, the banks went bust and the global financial system crumbled.
Learn about financial crises.
The major decline meant that many borrowers were left with zero or even negative equity in their homes – which is what happens when homes become worth less than the mortgage.
During the housing market crash of 2008, the average UK house price dropped by 15% and the average US house price fell by 20%.
Is the housing market going to crash?
The short answer is that no one really knows. The current financial situation is reminiscent of the previous 2008 housing crisis in a lot of ways: rising interest rates, coupled with a cost-of-living crisis and a boost in home ownership.
Over the past few years, the housing market has proven resilient and grown consistently despite Brexit, the coronavirus pandemic and the cost-of-living crisis. The average house price has risen by approximately 34% since 2020 – from £275,000 to £367,760 as of September 2022.
However, the Bank of England (BoE) has raised interest rates to 2.25%, their highest level since 2008 – when the base rate hit 5%. And predictions say rates could hit 6% in the coming year if inflation isn’t brought under control.
It’s a similar story on the other side of the Atlantic too, with the Federal Reserve announcing a 0.75% interest rate increase to curb inflation and the median house price climbing by 19% for the year.
And the combination of rising rates, inflation and the risk of a recession could mark the start of a house price decline.
Some experts predict that the UK housing market could crash by between 20-40% over the next couple of years. That’s because data from the Bank of England suggests that over two million borrowers are set to come off fixed-rate deals before the end of 2024 and might be in a position where they can no longer afford their mortgage payments.
Analysts at Pantheon Economics have calculated that an average household would see monthly repayments jump from £863 to £1,490.
And with the pound falling to historic lows against the dollar, some mortgage lenders have even pulled their deals altogether.
How would a housing market crash impact markets?
A housing market crash would impact markets by influencing the attractiveness of the country’s economy as a whole.
During periods of strong economic activity, a large portion of gross domestic product (GDP) is often made up from the housing market – both in terms of the number of home purchases and the growth in demand for the construction industry. This boosts both the domestic currency and other markets such as stocks and bonds.
So, when the housing market declines, so does GDP and the entire economic outlook – meaning there will be fewer home-starts, more unemployment and a decrease in investment.
Housing market crashes and forex
When housing market data is positive, central banks are more likely to raise interest rates to keep inflation in check. This would attract foreign investors as domestic bank accounts become more appealing, which would lead to a rise in the value of the domestic currency.
But when the housing market starts to decline, central banks are likely to try to boost growth by cutting interest rates to encourage spending. As a consequence, there will be less demand for the currency – causing it to fall in value.
If we take the UK, this would mean that a housing market crash would see the pound fall. So, traders would look to short the pound against other currencies, such as the USD, euro or Japanese yen.
Housing market crashes and stocks
A housing market crash would cause the shares of companies across the industry to suffer. For investors, this creates a difficult environment, but for speculators it creates the opportunity to short company stocks.
Businesses that would likely perform poorly if there was a housing market crash are:
- Homebuilders – including Barratt Developments and Taylor Wimpey
- Real estate agencies – such as Rightmove and Kingfisher
- Home-improvement retailers – including B&Q and Screwfix
- Real estate investment trusts (REITs) – examples include the EPRA UK REIT index, Landsec, Persimmon, Hammerson, British Land and Berkley
Learn more about trading REITs.
If you’re considering shorting these companies, you’d profit if they fall in value. But if your prediction was incorrect and they rose in price, you’d make a loss.
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