Over the past year many developed economies have seen rapid growth in their housing markets, as we identified back in October. As this continues, more experts are questioning how sustainable this trend is, and what it could mean for broader financial stability.

There are straightforward reasons for the success of the market over the past year. Stuck inside during lockdowns, people have been building savings and are beginning to reassess their priorities as working from home becomes a staple. This has been further incentivised by the measures brought in by governments to encourage economic action over this period, including stimulus cheques and historically low interest rates.

Why are House Prices increasing?

It may seem confusing that the house market is booming while so much of the economy is facing a strong headwind, but if we look at a map of where the biggest price rises have been, some of the reasoning becomes easier to understand.

Rather than cities experiencing a high demand, people are now trying to move out of urban centres into rural areas, where they feel they will have more space both to work and live. This corresponds with a greater demand for family homes, which were already in short supply, and are now experiencing greater demand than ever.

In the UK this has also been exacerbated by the Stamp Duty Holiday which was in place from 8^th July 2020 to 30^th September 2021. Under this policy the nil rate band cap was temporarily increased from £125k to £500k until 30^th June 2021, and to £250k until end of September.

This was part of a broader trend of government policy to encourage spending which was implemented to help keep the economy moving through the strain of the various lockdowns. Other measures included cheap loans to businesses, the furlough scheme and extremely low interest rates.

All of these factors have led to a huge demand for homes, coinciding with a year of problems for the construction industry resulting in low supply and ultimately pushing prices to record highs.

International trends

The same trend of growth has been reported by the vast majority of countries, demonstrating just how potent this combination of influences has been. The UK has seen house prices rise more than 20% since 2015, and across the OECD the statistics are equally stark with the annual growth over the pandemic passing 8%.

This dramatic and widespread growth indicates how many governments are willing to take the risk to ride this trend forward, betting on it as a major force for economic revitalisation in the post-Covid era.

However, the apparently universal nature of this trend also raises questions for the potential dangers.

How dangerous is this?

While the housing prices growth appears to be an encouraging sign, there is a chance that it will soon prove to be a bubble.

Claudio Borio, head of the monetary and economic department at the Bank for International Settlements, spoke about the important role banks have played in supporting the global economy over the past year. Differentiating this crisis from that of 2008, he stated that the pandemic “found banks in a strong financial position, to the point where policy makers have looked upon them as part of the solution rather than part of the problem.”

For the most part, this has taken the form of lines of credit continuing to be extended, further encouraging spending and providing stability. These low borrowing costs have made house prices more affordable, leading to greater demand, yet banks are now showing the strain of this policy. Lower than expected performance has contributed to a decrease in valuations – if this continues, the support they have been providing may begin to dry up.

Furthermore, the spike has been driven by temporary factors, such as the difficulties which the construction industry has been experiencing during the pandemic. This has exacerbated an existing shortage of supply to overvalue whatever can be found on the market. Adam Slater, from Oxford Economics, suggested that this overvaluation could be as much as 10% when compared with long-term trends, a number reminiscent of the 2006 boom, where overvaluation was estimated at 13%-15%.

The Covid-time government measures are another factor which we may soon see the end of, with the rush to return to normal leading to

a decrease in tax incentives and other stimulant spending. Whether the public will respond to this shift with renewed spending or a greater frugality, is yet to be seen.

Perhaps the most important factor, however, is the rate at which housing prices have been rapidly outstripping incomes. The relationship between the two is becoming ever more disproportionate, as while housing prices have exploded, wages have comparatively stagnated over the same period. As a result of this, buyers may soon cool on the prospect of buying at such inflated rates – particularly since the cost of renting has remained steady.

Predictions for the Future

Though these factors are concerning, the future may be far less dire than they might suggest as there are mitigating elements which differentiate the present situation from that of previous crises.

First of all, the role banks are playing is testimony to the fact that lessons have been learned from the previous housing crisis and are more set on avoiding a similar disaster. Adhita Bhave, economist at Bank of America, claimed that those making policy are “now acutely aware of the risks around housing policy”, and that that “meaningfully reduces the chances of an adverse outcome”.

The situation of the public is also different. Demand is now being driven by those with greater spending power, and with significantly less debt than previously, this makes a cascading sequence of bankruptcies less likely. The UK’s Credit Growth has remained low to maintain this, keeping private spending constrained.

Many experts have been making sobering predictions upon the fate of the economy post-Covid. World Bank Group Vice President for Equitable Growth, Finance and Institutions, Ceyla Pazarbasioglu, observed that “the crisis likely to leave long-lasting scars and pose major global challenges”, while World Bank Prospects Group Director Ayhan Kose stated that “The COVID-19 recession is singular in many respects and is likely to be the deepest one in advanced economies since the Second World War”.

Yet thanks to the prudence with which financial institutions have approached the challenges of the last two years, it seems possible that the long-term impact of the coronavirus – at least for the housing market – could be more manageable than anticipated.