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The Pandemic Property Boom

Last year, the world economy crashed, so why did property prices boom? Andrew Kenningham of Capital Economics in London looks at what’s happening and asks if it can last.

7 October 2021

It’s not just New Zealand. There’s been a pandemic property boom around the world.

In the UK, for example, house prices rose by 7 per cent over last year in December – and that’s despite the economy suffering its biggest contraction since 1709.

The US saw a similar rise, and in Canada prices rose by 13 per cent year on year. So, the whopping 18.5 per cent year on year increase in property prices in New Zealand in November is just an extreme example of this global phenomenon.

An unusual recession

Few predicted a property boom when the pandemic hit last year, but it’s not difficult to explain, with the benefit of hindsight.

There are three key factors:

1. In many countries, people are spending more time working from home than ever before, as governments have clamped down on commuting and tourism. A spare bedroom, home office, and a garden have never been so desirable.

2. Household finances have held up better than many imagine. Governments have stepped in with income support and measures to limit unemployment. Many people have ‘pandemic savings’ because of the limited options for spending when hotels, restaurants, cinemas, and nightclubs shut, and tourism came to a halt. In Europe and New Zealand, the additional savings which have accumulated are worth around 3 per cent of gross domestic product (GDP) – a significant amount.

3. But the most important factor is the third one. The cost of borrowing to buy a house has never been so low. In the US, 30-year mortgage rates have fallen from 3.5 per cent in January 2020 to below 3 per cent today, and in the UK and New Zealand, mortgage rates have also dipped. House prices might be higher, but they’re also more affordable.

Not all property is equal

That said, not all property prices have risen.

House prices rose more in the suburbs than in inner-cities, as people itched to escape the madding – and infectious – crowd.

Working from home has released people from the restraints of commuter lives.

At the same time, deserted retail and office spaces have left many high streets feeling like ghost towns.

In contrast, due to the boom in online shopping, warehouses are suddenly hot property.

Will it last?

Many people have suggested that the boom has now turned into a bubble which, by its nature, is likely to burst.

Economists define bubbles as a situation when prices can’t be justified by the fundamentals and demand is driven by people whose aim is simply to sell at a higher price later.

It’s often difficult to know whether there’s a bubble until after it has burst, but property prices now look very high by many of the conventional measures, such as prices compared to average incomes.

What’s more, there are signs of over-exuberance in the market for other assets, such as technology stocks, Tesla shares, gold and even Bitcoin. And bubbles often arise in more than one asset class at a time.

One concern is that some of the forces which boosted property prices during the pandemic will go into reverse when it ends.

As lockdowns are lifted, demand for property from those fleeing the cities will fade. We may all be desperate to socialise, throw parties and go on holiday, rather than invest in new homes.

Governments will also withdraw some of their support when the economy reverts to its pre-pandemic ways; indeed, politicians in some countries are already clamouring to raise taxes.

In many cases, governments directly supported the property market by cutting taxes on property transactions or through other measures to promote bank lending; these too may be reversed.

Red-light warnings

Just as low interest rates have been the most important driver of the property boom, so the biggest threat is that central banks raise interest rates.

If they do, houses may soon become unaffordable at current prices and demand could collapse, prompting a slump in prices.

While central banks may want to take some of the heat out of property markets, the only reason they would hike interest rates substantially is if inflation started to rise.

Some warning lights of inflation are already flashing red: the money supply has expanded exponentially, and government deficits have shot up.

In some countries, including New Zealand, measures of underlying inflation have begun to edge up and are likely to rise further this year.

Low risk of a crash

For now, though, the risks of a big increase in inflation and interest rates seems low.

The last time the world suffered from runaway inflation was in the 1970s. Then, oil prices were skyrocketing, trade unions were flexing their muscles, and central banks were under the thumb of politicians.

Happily, none of those things is true today.

What’s more, if inflation were to rise, central banks could use other tools to tackle it, such as putting a ceiling on housing loans relative to the value of the property being purchased (LVRs), rather than by jacking up interest rates.

Overall, it seems likely that there’ll be some cooling of the property market in many countries this year. But a major collapse in house prices, triggered by a significant adjustment in expectations for interest rates, still seems unlikely.

Definitions

Gross domestic product (GDP): GDP is a measure of a country’s market value. It covers all goods and services produced within a timeframe and can be used to compare nations.

Loan-to-value ratio (LVR): LVR is the percentage a loan makes up of your house’s value.

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