Housing prices are falling around the world — a casualty of steep interest rate hikes over the past one year. We do not think it will trigger another global financial crisis (GFC), as it did in 2007/08. For starters, there has been a noticeable slowdown in housing construction after the GFC and, in many countries including the US, there is a supply shortage. Demand has outpaced supply, which should keep a floor to how far prices will drop, though falling affordability remains a key issue. That said, it is a risk that bears close monitoring, as we believe the worst for the property sector is still to come. A steeper-than-expected property price collapse could raise default risks and, in the worst case, trigger a systemic liquidity crunch.
Housing prices in most countries peaked from late 2021 to 2022 and are reversing sharply lower with the end of an ultra-low interest rate regime, which had driven prices steadily higher over the past decade. Price gains were particularly strong in major developed countries during the pandemic on the back of demand surge — many either bought or upgraded to larger houses as they worked from home, enabled by ample liquidity, higher savings and record-low mortgage rates. Even taking into account recent declines, prices are still mostly above pre-pandemic levels (see Chart 1).
Now, housing market analysts are predicting double-digit price declines from recent peaks for most developed economies as demand weakens. The rationale for the sharp reversal is quite simple — aggressive interest rate hikes around the world as central banks sought to regain control of the highest inflation rates in decades. As a result, mortgage rates have risen steeply over the past year (see Chart 2). For instance, in the US, the average 30-year fixed mortgage rate spiked from a low of 2.65% in January 2022 to as high as 7.1% in November. The rate has fallen back some in recent weeks, to 6.33% currently, but this is still almost 2.4 times higher than what it was just one year ago.
Take the simplistic example of an average Malaysian homeowner: The monthly mortgage repayment on a median home valued at RM320,000 would have risen from RM1,182 to RM1,417 — or 20% higher — in less than a year, with the average mortgage rate rising from 3.45% in December 2021 to 4.8% in November 2022 (see Table). Worse, the current interest rate hike cycle is not over — interest rates are expected to rise at least another 0.5% over the coming months.
It is also inevitable that higher borrowing costs will lead to fewer homebuyers and weaker demand as affordability — which has been declining globally over the past decade with rising price-to-income ratios — worsens further. Put another way, higher interest rates reduce borrowing capacity — therefore, it becomes much harder for people to qualify for mortgages for the house they want. Using the same table as an example, a prospective buyer would now need a minimum net monthly income of RM2,362 as opposed to RM1,970 previously to qualify for a loan to buy the same RM320,000 home.
For most Asian countries, mortgages are based on variable interest rates (tied to central bank policy rates). This means the current cycle of interest rate hikes is hitting homeowners immediately — through higher monthly debt servicing repayments. Surging monthly debt servicing is compounding economic hardship for many households, already struggling with a rising cost of living. And this is especially so for countries such as Malaysia, where household debt is high. As mentioned above, however, we do not think it will trigger a global financial crisis.
There has been substantial home equity built up over the past decades, though recent homebuyers may be more at risk. Positively, financial institutions are generally well capitalised today and have been more prudent in their lending since the GFC. Importantly, unemployment is relatively low on the back of tight labour markets. We think mass layoffs are unlikely, at least at this point, though some sectors such as technology and cash-burn high-growth start-ups are starting to cut back.
The situation may be more worrying in countries such as Australia and the UK, where many recent mortgages have been structured as fixed interest rates for a short period (typically, two to five years) — to capitalise on the very low interest rates in the years prior to 2022. The fixed rate period of the majority of these mortgages will come to an end within the next two years, at which point the mortgages revert to variable rate loan or are refinanced with another fixed rate mortgage. Right now, these homebuyers would be looking at substantially higher monthly repayments very soon.
The UK’s Office for National Statistics (ONS) estimates that about 1.4 million households in the country will face a sticker shock when their fixed rate period ends in 2023. About 800,000 of these mortgages were fixed at interest rates below 2%. The average variable rate mortgage rate is now hovering around 4.4% while the interest rate on a new fixed rate mortgage is about 6%. These households were shielded from rising interest rates through 2022 but are now looking at significantly higher debt servicing costs — by at least 25% to as much as 50%, according to ONS.
That huge an increase could result in financial distress for some and, at the very least, would further erode household disposable incomes and consumption. Housing accounts for the largest percentage of household assets and falling values will create negative wealth effect on consumption — and drag for the broader economic growth.
By comparison, US homeowners are better insulated in the short term, given that the bulk of their mortgages are 30-year fixed-rate loans. This means, however, that existing homeowners are far less likely to buy a new home since mortgages will now carry much higher costs. And as we said, high rates translate into lower borrowing capacity.
Unsurprisingly, then, home sales and housing construction activities have slowed globally — and are likely to remain lacklustre for the foreseeable future, as central banks are expected to keep interest rates high for some time. The latest earnings results from the largest US banks saw consumer mortgage originations plummet. This could also be due, in part, to the banks themselves tightening lending and conditions, as the outlook for housing prices and the broader economy dims (see Chart 3). The slowdown in housing construction will negatively affect many upstream and downstream sectors, further adding to global economic woes. Case in point: Lumber prices have slumped (see Chart 4).
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The prevailing macroeconomic environment of rising interest rates and cost of living will further depress the moribund Malaysian property market. The sector has been struggling with excessive unsold houses for years (see Chart 5). As the situation gets worse, we may see higher defaults and foreclosures, which would hurt the banks. Home affordability is deteriorating and banks could tighten credit further. This backdrop does not bode well for property developers either — margins will be squeezed by both rising construction costs (raw materials, labour and financing costs) and falling demand.
The outlook in Singapore appears brighter. For starters, unsold private residential units are at the lowest in about 15 years, exacerbated, in part, to delayed completion because of pandemic disruptions (see Chart 6). Demand, too, is expected to stay comparatively resilient, even with the government’s recent cooling measures, underpinned by foreigner demand — Singapore is the regional hub for MNCs and family offices, and a safe haven — including wealthy Chinese citizens.
Of course, there are views totally opposed to ours, such as a recent report by UBS Research. It holds a bullish outlook for real estate, predicated on the assumption that global inflation will moderate quickly — allowing for a US Federal Reserve pivot in 2H2023. UBS forecasts that the federal funds rate will fall from a peak of 5.25% to 3.08% by the end of this year and 1.08% by end-2024 (see Snapshot). That is an extremely aggressive forecast. Will it happen? Well, nobody knows. But based on what we know now, it looks more like pie in the sky. It makes a very good talking-up story, though, to do some business, no? As we said, money talks, bullshit walks!
The Global Portfolio was up 1.9% for the week ended Jan 16, compared with the 1.3% gains for the MSCI World Net Return Index. The top gainers were GoTo Gojek Tokopedia (+16.4%), Global X China Electric Vehicle and Battery ETF (+3.8%) and NEXT Funds Japan Bond ETF (+2.8%). On the other hand, Grab Holdings fell -0.8%. We added Tencent Holdings and Alibaba Group Holding to the portfolio. This means the Global Portfolio is once again near fully invested — about 35% in low-risk sovereign bonds, 27% in Chinese stocks and the remaining 38% in Asean-based stocks. Last week’s gains lifted total portfolio returns since inception to 30.2%, trailing the benchmark index’s 41.7% returns over the same period.
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