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When property becomes a roof and a floor again


The crisis is almost a decade past. Most developed economies are steady if not strong, and asset prices are almost universally high. Central bankers are either threatening to raise policy rates, or lifting them gently; either buying fewer bonds, or talking about selling some. For the first time in years or even decades it seems possible that interest rates might rise and keep right on rising. This is the possibility that the bond market has been responding to — nervously — since the end of June.

The stock market has registered the changed expectations too. Real estate, the other great asset class, must also feel the changed environment. Indeed it might be the most vulnerable of all. Given the villainous role of property in the crisis, and its blindingly fast recovery, it is natural to worry about a price crash should rates rise. Commercial property is the first place to look. US banks’ stock of CRE loans has been growing at near double-digit rates for several years. The US Federal Reserve said in February that spiralling CRE valuations left smaller banks vulnerable. In the UK, happily, banks exposure to commercial property, at about £80bn, is half what it was before the crisis. All the same, the Bank of England’s most recent financial stability report noted that the rental yields on commercial property were alarmingly low. It all but declared prices unsustainable. An abundance of office space in the City of London, in particular, will not help keep rents up. Even if foreign cash buyers take most of the pain in a correction, there will be unpredictable ripple effects. A CRE correction, even a violent one of 30 per cent or more, seems perfectly possible. The correction need not turn into a crisis, though. On both sides of the Atlantic, the stock of commercial property debt is not huge, relative to the size of the economy. Yes, what matters is not the leverage in the total system but the worst loans and where they are concentrated. Any trouble spots will be mitigated because banks’ capital buffers are thicker now.

Residential real estate is much bigger, has much more debt held against it, and in some places prices have run up with almost as much velocity as CRE. Yes, the £1.3tn in UK residential mortgage debt is supported by almost £5tn in equity. But a crash happens on the fringes, where marginal buyers and individual banks have taken on too much risk.Statistics about aggregate residential leverage (loan-to-value ratios) and affordability (payments-to-income) remain sane in the UK. But extreme price increases can make these ratios almost irrelevant. London is the obvious case of this. Property prices there are up a stunning 60 per cent from their pre-crisis highs, according to Nationwide. However, the trend is turning. Recent property surveys show that prices in prime London are falling. This year, more central London properties have been withdrawn from the market than sold. The short-term question is the probability of a hard correction, should rates in fact rise. In London at least, the risks looks real, but not dire, and corrections once begun tend to spread to unexpected places. The long-term question is broader. In a sustained rising or stable rate environment — something many developed countries have not seen in almost four decades — will houses cease to be the primary consumer investment? A house is not, after all, a productive asset. It is a shelter. Its power as an investment vehicle may be an artefact of a specific period in financial history. If that is true, many savers’ hopes will be dashed, and all of them will have to find a new place to put their savings. 

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