We all know there will be a collapse in house prices at some point. But when?

Just to draw a line in the sand, I’m going to define a “crash” as being a drop of more than 10% within 12 months. For context, after the last financial crisis there was a drop of roughly 16% in 12 months between April 2008 and March 2009.

A 12-month drop of less than 10% is still no joke, but doesn’t seem dramatic enough to be called a “crash” and would soon be recovered by a few years of typical annual growth afterwards.

So, let’s play a game of “what causes the next crash?”:

When the deadline for the Stamp Duty holiday passes? Now it’s too late to complete in time for the deadline, prices will cool because buyers aren’t in a mad rush and we might see lower transaction volumes later because demand has been “pulled forward”. That may cause prices to drop a little. But crash? No.

Spiking unemployment as a result of all the Covid shutdowns? Probably not, because many of those affected will be younger people who aren’t owners. Those owners that are affected will be shown forbearance by their lenders because repossessing as the result of a pandemic is a seriously bad look – so there won’t be a high number of forced sellers, which is typically what causes a big drop.

Lower immigration rates because of Brexit, or travel restrictions and general uncertainty? The typical belief is that we need to be building tens of thousands more homes than we are each year, just to keep up with growing demand. If you buy into that, any drop in immigration will just reduce that imbalance. If you don’t think there’s a shortage, then you could expect it to put some downward pressure on the market…but not enough for a crash.

Lenders getting nervous and tightening their criteria? Again, this would weigh negatively on the market but not be sufficient for a crash. And this is something the government has stepped in to “fix” in the past (Help To Buy), and is talking about doing again.

I can see how any of these reasons – or several of them combined – could slow price growth down or cause prices to drift downwards. But for a crash, I believe we need stronger stuff…

Are property prices unsustainably high?

When you look at property prices as a multiple of average incomes, they’re expensive by historical standards.

When you look at property prices in terms of the yields they produce, they’re expensive by historical standards.

Does that mean they’re too high – in a bubble, even – and due for an imminent crash?

Not necessarily.

Because when you take a broader look at the world, everything seems expensive.

  • The US stock market is close to all-time highs
  • Tech companies are trading at valuations that seem insane at first glance
  • Gold is close to an all-time high
  • Bitcoin is close to an all-time high
  • House prices are well above their previous 2007 peaks in Vancouver, Toronto, Munich, Aukland, Melbourne, Oslo, Vienna, Stockholm, Shanghai, Singapore, San Francisco…

Why? Rock-bottom interest rates.

When you get close to 0% by investing in government bonds or keeping your money in the bank, you won’t require much of a yield on an alternative investment – which pushes prices up.

When you can borrow money at negative real rates, you’ll be willing to pay more for assets — which pushes their prices up. When companies can borrow at negative real rates, they’ll borrow to buy back their shares or make investments – which pushes prices up.

Is it “wrong” to look at the homes people need to live in using the language of financial investments? Maybe, but it’s reality. This is why prices are so high in the global cities I listed: property there is being treated (and priced) as a financial asset, not a place to live. (Go to secondary and tertiary areas where houses are priced as homes instead, and you’ll see that affordability looks totally different.)

Investors will pay more for a property when debt is cheap and the alternatives are unappealing. And owner-occupiers? They can afford to take out bigger mortgages because the rates are so low, which keeps the costs of ongoing ownership affordable even though nominal prices are high.

So when you look at it this way, are property prices “in a bubble”? No, because a bubble is irrational – and the reasons for prices being historically high are entirely rational, and can be explained by low interest rates.

So how does the crash happen?

If low rates are the cause of high prices, clearly higher rates will be the cause of prices falling. So when will that happen?

There’s a school of thought that says “never”. The Bank of England and the Federal Reserve in the US have stated that interest rates are going to stay very low for a very long time. If you look at the trend line going back to the 14th century, interest rates have persistently been falling: the drop in rates since 2009 has been a reversion to the long-term trend, so future rates might go permanently negative.

But if interest rates do increase, the cause will be inflation. At the moment inflation is 0.7%, which is lower than the Bank of England would like. However, if inflation does take off and become higher than they’d like, the way to damp it back down is to raise interest rates.

What could cause inflation to take off? Well, printing an extra £300 billion in a couple of months might contribute to it. Actually it probably won’t, because the countervailing deflationary pressures are so strong, the economy is so weak and the mechanism means it won’t directly feed into consumer prices – but if they keep at it, surely at some point it will.

So for me, that’s currently the most plausible explanation for how the next crash will happen:

  • The government will keep printing money in an attempt to boost GDP and keep inflation close to its 2% target.
  • Eventually, they’ll over-shoot and inflation will start getting out of control.
  • The Bank of England will increase interest rates to bring inflation back down, which will cause the price of all assets (including property) to fall.

But when?

If my logic is correct that’s great and all, but it doesn’t really help us with the all-important “when?” question.

It does, however, tell us that the answer is “not yet”. If interest rates stay where they are and there’s no generalised crisis of confidence in the financial markets, I don’t see a factor that will produce more than a slight decline.

It also tells us that the answer is likely to be “when you least expect it”. Bubbles burst when there’s some trigger for everyone suddenly stopping and going “hang on: this is crazy”. The trigger for everyone starting to think that way might be the mechanism I described, or it might be something completely out-of-the-blue.

But now? Well, if everyone is anticipating a crash now, it almost by definition won’t happen. Although if it does, feel free to blame me.

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