Macroscope: As safe as houses?

Ninety One analyst Rebecca Phillips and strategist Russell Silberston query whether houses are a safe investment, and the possible economic implications if the housing market takes a dip

From 1870 to 2015, it has been estimated that the global housing market returned 11.06% per annum, or 7.05% in real terms[1]. This is impressive, particularly when we compare this performance to the more volatile and modest 10.75% return from global equities over the same period. It should come as no surprise, then, that the phrase “as safe as houses” has entered the common lexicon.

What people may not know, is that this period also captures one of the greatest housing downturns in history. This downturn scarred the US economy with a deflationary shock for nearly a decade and left many questioning the validity of property as an investment. In South Africa, the housing market fortunately held up well enough in rand value after 2008 to prevent any major write-downs, and the price of the average South African middle-class home maintained its value after this catastrophic event.

Looking back, it is easy to see the imbalance that was building within the US economy in the lead up to the Global Financial Crisis. Real disposable income ratios peaked at 1.1 times and household debt to GDP reached 99%. It seems incredible then - after many years of low interest rates and cheap money globally - certain countries have repeated the errors of the past, by leaving household balance sheets on the brink just as central banks began the fastest policy tightening cycle in history.

Specifically, we have identified six countries that face particular challenges: Australia, New Zealand, Canada, South Korea, Sweden and Norway. These economies never really de-leveraged after the Global Financial Crisis in the same way that the US did, and as a result they have seen their housing markets continue to inflate, while household debt levels have ballooned. For example, the ratio of real house prices to real disposable incomes in the three-dollar bloc economies (Australia, New Zealand & Canada) are around 2.5x, with household debt at or above 100% GDP. While debt levels are lower in the Scandinavian countries, with nearly all household debt having floating interest rates in Norway and the highly controlled Stockholm market seeing especially exorbitant prices in the city, these markets are vulnerable to rising rates too.

In a world where central banks are still battling to control inflationary pressures, we believe the impact of these imbalances may well become critical in turning the tide. As interest rates rise rapidly and banks tighten lending standards, these economies face significant headwinds to both growth and inflation as consumers try to overcome the hit to their disposable income.

Typically, as housing demand fades, leading indicators such as new housing starts fall and property prices turn over, feeding directly into inflation and growth. This cycle is currently at risk of playing itself out in South Africa, with data released by Stats SA last week showing that building plans for non-residential buildings at current prices fell by 25.9% for the first two months of this year compared with the same period in 2022, while residential property prices increased by 5,8% in the 12 months to November 2022. This is further exacerbated by the negative wealth effect on consumption and broader use of debt. Rising interest rates drive a tightening in bank credit standards, making any new loan or re-mortgage that much more expensive. This weighs on consumers disposable incomes and ultimately undermines consumption. As growth and inflation fall, central banks will be constrained in their ability to raise interest rates.

This is precisely what we are seeing in these vulnerable markets. In both Australia and Canada, for example, housing starts have fallen 33% from post-Covid highs, and property prices are well off their peaks in both countries. The Reserve Bank of Australia, therefore, slowed the pace of interest rate hikes and began to look towards a pause. Following its latest meeting, the Bank stated that “Growth over the next couple of years is expected to be below trend. Household consumption growth has slowed due to the tighter financial conditions and the outlook for housing construction has softened.” The Bank of Canada has similarly held at a level 1% below where we project Fed Funds to reach. Meanwhile, on the other side of the world, Sweden’s Riksbank is trying to find the line between the prospect of “falling house prices leading to lower housing investment, which will reinforce the economic downturn” and a weaker currency.

For reference, we see the UK housing market as falling somewhere in the middle of these dynamics; while it hasn’t inflated as much as the economies highlighted, households have failed to de-leverage to the same degree as the US. With housing associated activities making up over a quarter of domestic GDP, it is likely that the UK will see some impact closer to home. In South Africa, the latest forecasts point to a bleak outlook for the housing market, with price growth expected to slow to its lowest level in 15 years and weaker demand likely to extend into 2024. Despite the slowdown in activity, however, industry players believe the local housing market will avoid a “bubble”. This is mainly because South African house price inflation remained in low single-digit territory over the past three years. In contrast, house prices in many offshore markets surged by double-digit rates from 2020-2022, and now face huge downward corrections. Still, the SA housing market is unlikely to be immune to a recession, which seems increasingly likely, given the possibility that the economy has again contracted in the first quarter.

In conclusion, we would be surprised if, as higher interest rates begin to bite, the economies that have grown material household and housing market imbalances over the past decade of easy money don’t find themselves exposed to notable downside surprises in both growth and inflation over the next 12-18 months. We believe this presents opportunities in government bonds in these markets and is likely supportive of currency depreciation in these nations’ currencies against structurally stronger reserve currencies.