House prices have broken free from reality and defied gravity for far too long, but they are an asset like anything else, and there are six clear reasons a nasty correction looms in the coming year.
Asset prices around the world soared as central bankers embarked on the greatest money printing experiment in history. While much of that money flowed into the stock market, a great deal also found its way into house prices. What we are now witnessing on trading screens around the world is the unwinding of the era of monetary excess, and house prices will not escape the fallout.
The end of easy money began when the US stopped its third quantitative easing programme in October 2014. That date marks the point the US balance sheet, or amount of money in the system, stopped rising, having soared from $800m in 2008 to more than $4 trillion.
Without an ever-increasing supply of money the world economy is now slowing sharply.
The first assets to be impacted by the downturn were commodities. The price of things such as oil are set daily in one of the largest and most highly traded markets across the world and as a result it is highly sensitive to any changes in demand and supply. Admittedly there are also supply-side factors impacting the oil price, but the weak demand from a slump is still a major factor.
The next asset to fall was share prices. There was a delay of about 12 months because even though shares are also traded daily, their value depends on the profits of the company, and the impact of the commodity collapse took about a year to feed through.
There is a delayed effect on property prices because the market is so inefficient.
Transactions can take up to three months to complete and the property itself may have to languish on the market for even longer. The prices are also dictated by estate agents, who have an interest in inflating them to raise fees. The number of transactions is also still about 40pc below that of 2006 and 2007, which allows prices to stray from the fundamentals for a longer period.
It is true that Britain is suffering from a housing shortage, which drove UK house prices to a record high of an average of £208,286 in December, but like all asset prices they are on borrowed time. The fundamentals of demand and supply in UK housing will undergo a huge shift in the year ahead.
Death of buy-to-let
A large portion of the demand for UK housing will fall away as the benefits of buy-to-let have effectively been killed off in recent budgets.
George Osborne slapped a huge tax increase on buy-to-let in the summer Budget, which will take effect from 2017 onwards. The removal of mortgage interest relief was the first stage and was followed by hiking stamp duty four months later in the November review.
This could prove a double whammy on the housing market, turning potential buyers into sellers, and flooding the market with additional supply. A survey of landlords suggested 200,000 plan to exit the sector. The rapid growth of buy-to-let during the past decade looks set to be slammed into reverse.
Overseas buyers strike
The UK property market has been a highly attractive place for wealthy individuals across the world to protect their savings. However, many of the biggest buyers have been forced out of the market.
Chinese buyers have been locked out by state controls which mean each person is restricted from taking more than $50,000 (£34,000) a year out of the country. The stock market collapse will also destroy wealth.
The Russians have also had their wings clipped as the country’s economy goes into freefall. The Russian ruble has collapsed in value by 90pc against the pound during the 18 months.
The oligarchs have also seen their wealth evaporate as their holdings in mining and oil companies slump in value.
The petrodollars from Saudi Arabia have steadily flowed into UK property for more than a decade, but the Gulf nation’s investors are now pulling those funds out at a rapid rate to support the economy at home.
A fire-sale of assets is taking place to plug the largest recorded budget deficit in history. The shares will go first followed by the homes.
Interest rate shock
Interest rates have been held at emergency lows in the UK and US for around six years. The US has moved first, with rates rising to around 0.5pc last month. UK rate rises are expected to follow shortly after.
The impact on the cost of mortgages will be dramatic. An entire generation of homebuyers don’t know what an interest rate is. In the US following the December rate rise the cost of mortgages has soared by 50pc.
The current market expectation is for the interest rate to rise four more time to about 1.5pc by the end of the year, or some 300pc higher than its current level.
Drowning in debt
UK households are simply drowning in about £40bn of debt according to the latest figures from the Office of Budget Responsibiliity. When budgeting is this finely balanced, it doesn’t take much to tip it over the edge.
The UK economy is weighted towards financial services and a collapse in markets could cause a painful correction.
Britain’s housing market has defied gravity and logic for far too long. Government intervention by way of cheap help-to-buy loans allowed it one last hurrah, but the limits of state intervention are being brutally exposed in China, the UK is no different.