The property crisis just started
Friday, 3 August 2018
By Sam Volkering
- 2009 in repeat
- This is real stress
- UK, Australia, it’s happening everywhere
It hasn’t been this bad since 2009.
Here in the UK, the Bank of England has upped interest rates by a whopping 0.25% to 0.75%.
Now you might giggle at the ridiculously low rate. But rates haven’t been this ‘high’ in the UK since 2009. That was when the Bank of England slashed rates from 5% to 0.5% in the wake of the debt crisis.
And an increase like this isn’t going to send the country into a horrible downward spiral. At least, not just yet.
But there is a big problem with a rate rise. This will become an even bigger problem as rates return to historical norms.
You see, for almost a decade now, people in the UK have been living in this low rate environment. For 10 years debt has been cheap.
You can get fixed rate mortgages at rates around 1.75% for two years. And even the standard variable rate from high street banks is 4.72%.
However, most people who’ve recently taken on debt have done so with little regard for history. And even those who had debt before 2009 have fallen into a false sense of security.
Rate rises could lead the UK into a property death spiral. And as we’ve been saying for some time, this death spiral is also likely to hit Australia.
Overnight the Dow Jones Industrial Average closed down 7.66 points, or 0.03%.
The S&P 500 gained 13.86 points, or 0.49%.
In Europe, the Euro Stoxx 50 index finished down 40.02 points, or 1.14%.
Meanwhile, the FTSE 100 is down 76.98 or 1.01%, and Germany’s DAX is down 190.72 or 1.50%.
In Asian markets, Japan’s Nikkei 225 is up 21.55 points, or 0.094%. China’s CSI 300 is down 0.42%.
In Australia, the S&P/ASX 200 is down 8.40 points, or 0.13%.
On the commodities markets, West Texas Intermediate crude oil is US$69.04 per barrel. Brent crude is US$73.39 per barrel.
Turning to gold, the yellow metal is trading for US$1,208.17 (AU$1,639.05) per troy ounce. Silver is US$15.31 (AU$20.77) per troy ounce.
One bitcoin is worth US$7,337.99.
The Aussie dollar is worth 73.70 US cents.
The definition of stress
There are more than 3.5 million residential mortgages on variable rates in the UK.
This only accounts for around one third of all residential mortgages in the UK. The rest are fixed rates.
The thing about fixed rates is they are fixed also for a period of time. Typically they’re around two years.
I’ve searched high and low but can’t find the most important statistic of all — the number of people coming out of a fixed interest period.
When you’re out of a fixed rate period you’ve got one of two choices: re-mortgage for another fixed period or move to the variable rate.
Every fixed rate mortgage moves to the standard variable rate at the end of the term. That can see an interest repayment more than double if you’re not on top of things.
Even if you remortgage to another fixed rate, that rate is likely to be higher than the rate you’re used to. And if you aren’t able to remortgage to another fixed rate, then you’re truly screwed.
What if your situation has changed? What if you’ve gone from a two- to one-income household? What if your daily living expenses — such as food and utilities — are higher, thanks to central bank-controlled inflation?
Imagine your mortgage repayments doubling overnight.
Could you handle that jump? Most people couldn’t.
The other problem that occurs derives from the fact that when money is cheap, borrowers are encouraged to borrow a lot. Banks take affordability into account — but not at potentially double the repayment.
That responsibility is only yours.
You simply borrow as much as you can to get the nicest house you can. And if you’re only ever used to cheap money, you assume it’ll be cheap forever. Until it’s not. And then you end up with a massive economic problem.
This is a problem that’s going to hit young people.
It’s a problem where young people who want to live in expensive areas borrow to the max with cheap money and denial. I’ve already heard from people about their stress of refinancing, or having to move to a variable rate.
They’re worried about how the heck they’ll meet their repayments. They’re worried about the bare necessities. They’re living in nice homes which they can’t afford.
As work continues to centralise into urban areas, more people are drawn into cities. And the values of homes in these areas continue to rise. And young people, who are just getting into the property market, continue to pay over the odds for these homes.
But they don’t think about what life is like, should rates hit 5%, or 6%, or even 10%. They don’t think about what happens as repayments push higher and their wages don’t track higher.
Overstretched and underprepared is going to be a defining concept of a whole generation. It’s going to smack Gen Y and the dot-com generation right in the face.
A global problem
This issue isn’t isolated to the UK. The same thing is happening right here in the major cities of Australia.
I’m talking about balancing an egg on a toothpick. And it’s ready to topple at any moment.
In Australia, it’s a similar problem of expensive property, highly leveraged homes, stagnant wages, increasing living expenses and a lack of foresight.
If interest rates were to rise, you’d see even more mortgage stress. You’d see discretionary spending dry up. It would all be reallocated just to pay the bills. This would have a horrible lag on the economy.
But you’ve got a central bank that really, really doesn’t want to lower rates anymore. They have to try and keep the dollar and inflation under control, and they have to do all this without starting a property crisis.
You’re seeing right now the beginning of another property crisis in the UK. It’s going to mainly hit the south, in and around London. It’s going to see forced sales, a surplus of stock — a buyer’s market.
It’s going to get worse over the next three years as the BoE pushes rates higher and higher.
You’re also now starting to see the early stages of an Aussie property crisis. It will hit the major cities in Melbourne and Sydney. You’ll see forced sales, surplus of stock — a buyer’s market.
It will get worse over the next three years.
I have consistently said for the last two years that, in my view, buying property in Melbourne and Sydney is a horrible idea. That if you’re a young person, hold off, and continue to build wealth elsewhere until the crisis strikes.
And the same applies for any young person in the UK. Hold, wait, and build wealth elsewhere for the next couple of years.
When property prices fall, when the sellers get desperate, that’s when you strike.
That time is coming, so you better get ready for it.