Global real estate prices have uncharacteristically surged during the recession. It didn’t come without consequence, warned the International Monetary Fund (IMF), this week. The agency’s regular Financial Stability Report said global home prices are now stretched. Stimulus policies backstopped the market, creating moral hazards. Buyers now have a “can’t lose” feeling, pushing them to pay risky premiums for property. As a result, the agency now sees a significant downside in a worst-case scenario. Their model shows the worst-case scenario has double the downside compared to pre-pandemic.
Home Prices Have Been Soaring Across The World
Home prices across the globe have been rising during the recession, which is odd, to say the least. They found soaring home prices and record sales in advanced and emerging economies. The agency attributes this to supply asymmetries, low rates, and rising disposable income. These factors have combined to drive demand (and prices!) much higher.
Typically housing correction risks are due to loose lending, and a recessionary shock. They say this isn’t the case this time. Banks are in a much better position than they were during the Global Financial Crisis in 2008. Forbearance policies have also pushed delinquencies lower, skewing price growth to the upside. This gave homeowners a significant equity windfall, sometimes exceeding their household income.
Rapidly Rising Home Prices Across The Globe IS The Risk
Rapidly rising home prices and lofty gains are the risks. A boost to home equity gives some people a cushion to weather a storm, but also a euphoric high. Lenders eliminating the risk of default and high price growth created moral hazards. The thinking has shifted to, “if they can backstop prices now, they’ll always do it!”
The IMF warns this moral hazard is creating a risk of people believing any price is justified. “Sustained periods of rapid growth in house prices can create the expectation that such prices will continue to rise in the future, potentially leading to excessive risk-taking and rising vulnerabilities in housing markets,” wrote the agency.
People now think the risk of paying more later will always be greater than the risk of losing. This can lead to paying premiums that don’t make sense in practical terms. This can get out of hand pretty fast.
Global Home Prices Have “Significant” Downside Risk Now
Just how bad is the downside risk? “Significant,” said the agency when discussing its worst-case scenarios. In the latest report, the IMF said advanced economies can see a 14% drop in prices on average (rolling back 17% of gains). This is up from the 6% drop in the worst-case scenario pre-pandemic. The timeline for the bottom would be three years after the peak.
Downside Risks For Home Prices In Advanced Economies Rises
The current probability density of home price movements in advanced economies, compared to pre-pandemic risk.
Source: The IMF.
The IMF elaborated, the downside risk is relative to the country’s fundamental misalignment. Countries with a low disconnect from fundamentals would see smaller declines, if any. Those with large disconnects would be overrepresented, and see greater drops. One also assumes the effectiveness of policy support plays a role. An inefficient market can only be extended so long before it spills over into other issues.
Market Inefficiencies May Begin To Spill Over And Undermine The Recovery
Speaking of market inefficiencies, why can’t they just prop up prices to infinity? Well, another risk stated in the IMF report is the impact on inflation. If high home prices trickle into rents, this drives inflation higher. Shelter costs are the largest component of the inflation basket. Everyone needs shelter, including all of the producers and service people. As their costs rise, so do the input costs of goods and services.
The higher cost of living, especially inflation not captured by CPI, becomes a big drag. As the cost of living rises, more capital is diverted from spending into essentials. Since one person’s spending is another person’s income, it can undermine recovery. A slower recovery (or double-dip recession) would end up impacting home prices anyway.
Remember, global home prices are rising, but not to the same extent everywhere. Canada and Germany’s home prices made much sharper gains than other G7 countries. This would leave them at a much greater degree of a correction risk. The same can also be said about cities. Earlier this year the IMF warned Toronto and Hamilton housing is much more disconnected than Calgary or Montreal. Montreal wouldn’t need nearly as large of a correction to get back to fundamental values.
Like this post? Like us on Facebook for the next one in your feed.