The Drop in Housing Prices Starts to Impact Economies: How the Real Estate Crash Threatens GDP

Canada, Australia, New Zealand, and Sweden Already Facing Serious Declines

Authors: Mario Becedas/Vivente Nieves

Source: El Economista

When part of a body suffers, it can affect the entire system. The same happens with housing and the economy. The drop in property prices, which is already being experienced in some countries—particularly in certain economies—threatens to worsen already bleak prospects given the unfavorable winds looming for developed markets.

The real estate downturn can impact economies. Residential investment will weigh down more than one GDP, while falling housing prices will affect household spending decisions through the wealth effect. This decline in housing, the main asset of households, usually triggers a reduction in family consumption as they tend to save to ‘compensate’ for the decrease in the value of their asset.

“We continue to believe that the weakness in real estate markets will contribute to the recessions we expect this year in most major developed markets,” argues Vicky Redwood of Capital Economics. The expert notes that construction activity is already feeling the strain, and although it is difficult to detect significant adverse effects on household spending, it is likely that this only reflects temporary delays.

In Canada, Australia, New Zealand, and Sweden, where prices started to decline almost a year ago and are now between 7% and 13% below their peak. Housing prices have fallen most rapidly in Sweden, where a large proportion of households have variable-rate mortgages. Capital Economics estimates that housing prices in these countries are roughly halfway through their eventual adjustment, though they leave open the possibility of larger declines than expected.

In the U.S., the U.K., and Germany, housing prices have only recently started to fall, so the largest price drops are yet to come. In Germany, the EPX index recorded a 0.8% drop in December, the first since 2009. In the U.K., analysis suggests that the bulk of the decline will occur this year, based on the decreases already observed.

There is also a possibility that housing prices will start to fall in other countries that have so far resisted. This includes other European countries like Austria and Portugal, due to the overvaluation of their housing markets and the high proportion of variable-rate mortgages in new loans. In Austria, it was reported this Tuesday that residential property prices fell by 1.9% in the fourth quarter compared to the previous three months, the largest decline since 2011. The Netherlands also appears vulnerable due to its high level of mortgage debt relative to income.

The real estate recession in the first group of countries has progressed enough to affect economic growth. This has been most evident in housing construction activity. Residential investment as a percentage of real GDP has fallen more sharply in Canada, from a peak of 8.7% in the first quarter of 2021 to 6.6% in the third quarter of last year (a reduction of around 1.7% of GDP over those 18 months). In Australia, it dropped from a peak of 7.3% in mid-2021 to 6.4% in the third quarter of last year, representing a reduction of 0.5% of GDP, according to the firm.

Australia is particularly concerning for analysts at Nomura, who recently published their latest global economic growth forecasts. Although many regions are expected to experience slower growth or even fall into recession, Nomura analysts have highlighted those with the highest internal risk to economic growth due to housing.

Previous analyses have identified Australia as a potential epicenter of a real estate ‘quake,’ and Nomura experts confirm that economic momentum in Australia is fading. Beyond inflation and the slowdown in China, “survey data and PMI readings have also declined. Moreover, we expect these trends to continue as interest rates rise further and fixed-rate mortgages gradually adjust to much higher levels, leading to a consumption- and housing-driven recession starting in early 2023.”

Redwood admits that, although the most timely indicators point to further declines in construction activity in most countries, they do not suggest an imminent collapse. In Canada, the decline in construction has been driven by reduced spending on renovations, but weakness in pre-construction sales and a moderation in the issuance of residential building permits suggest that housing starts will also weaken soon. In the U.K., the housing construction component of the S&P Global/CIPS PMI fell to its lowest level since the start of the pandemic in December. The outlook is perhaps more pessimistic in the U.S., where the steep decline in builder confidence points to a much lower level of housing construction.

Another main channel through which the housing slowdown might be affecting economies is consumer spending. The drop in housing transactions tends to affect spending related to moving (such as new furniture and appliances). “The drop in mortgage applications and approvals suggests that transactions in the U.K. will fall soon, with further declines expected globally. The exception is the U.S., where mortgage applications seem to have hit their lowest point,” notes Redwood.

Falling housing prices could also have more general adverse effects on consumer confidence, leading households to save more and spend less, reinforces the analyst. Indeed, household saving rates have recently declined. “Looking ahead, we think housing declines will contribute to a slight increase in household saving rates or, at the very least, act as a barrier to them falling much further,” forecasts the Capital Economics expert.

“In the U.K., the downside risks to our revised growth outlook come from the housing market, where we expect a decline of up to 15% in nominal housing prices in response to higher mortgage rates and a sharp slowdown in activity. There is also the risk of a double-dip recession later in 2023 if energy prices do not stay at current levels (if they rise again). In this regard, we note that the consensus is weaker than our new GDP outlook,” say Nomura experts.

In the U.S., the housing price decline is also harming the economy. “As the housing market recession deepens and an early slowdown in the industrial sector emerges, we expect consumer spending strength to wane, with confidence remaining historically depressed and real income growth sluggish. The pace of contraction may be mitigated by the solid balances of businesses and households. However, the lack of support from monetary and fiscal policy is likely to result in a more prolonged recession than average, followed by a gradual recovery.”

Nomura also emphasizes that developed Asian countries are suffering the weight of the real estate decline on their economies. South Korea and Taiwan are no exceptions. Japanese bank experts also see real estate as a major risk to their economies: “The increasingly intense recession in the housing market poses downside risks to GDP growth, while a more resilient labor market is an upside risk to consumption. Higher electricity prices are an upside risk to inflation,” they warn, referring to both countries.

Housing prices in South Korea have fallen nearly 2% in a single month (between December and November), the deepest drop since records began in late 2003 and the seventh consecutive month of decline, according to data from the South Korea Real Estate Board released Monday. This drop follows a 1.37% loss in November and marks a 4.68% decrease for all of 2022, a total reversal from the 9.93% price growth in 2021, the statement says. This is a relatively surprising trend in a country where housing prices have steadily and strongly risen in recent years.

In Hong Kong, Nomura experts also identify housing as one of the major risks to the economy. Initially, inflation does not seem to be a risk for this economy, as it fell to 1.8% year-on-year in both October and November, down from 4.4% in September. Inflation in utility prices, clothing and footwear, restaurant and takeaway meals, and basic foods were among the main contributors to the November CPI inflation. However, aside from inflation, it is expected that “in 2022 as a whole, housing prices fell by 15%… On the negative side, the local economy still faces significant difficulties due to a depressed Chinese economy, the ongoing drag from the housing market, caused by the aggressive normalization of Federal Reserve policy, and the non-linear effects of the expected recession in advanced economies,” the experts conclude.