It is extremely easy to look back in hindsight and spot the “obvious” house price bubble – at the time it is not as easy as many of us would suggest. Or is it? One of the main problems with a buoyant property market is the fact that people get carried away paying prices which, if they sat back and thought about it, are far too high. Whether using rental yields or income multiples as a barometer, when house prices are approaching bubble status all sensible thinking tends to go out of the window.
Risky loans
In the aftermath of historic house price bubbles we see the regulator stepping forward to stop “risky” lending. At the time this seems perfect, slowing down the housing market, chocking finance and bringing some common sense back into the marketplace. However, you will notice that slowly but surely as things begin to pickup the number of risky loans will slowly rise.
Increased leverage
Any house price bubble you research will have a degree of increased leverage as the market begins to get out of control. In effect, in tandem with more risky loans, buyers are only obligated to put down relatively small deposits taking the rest as finance. If example you put down a 5% deposit on a property worth £100,000 then the loan to value ratio is 95%. So, let us assume the market was overvalued by 15% and eventually corrected itself. That £100,000 property would then be worth £85,000 which is less than the £95,000 capital outstanding.
Low salary growth, high cost of living growth
Low salary growth is a dangerous development in the midst of a house price bubble when occurring in tandem with high cost of living growth. This effectively means that the cost of living element of income will increase gradually over time leaving less money to cover financial expenses such as a mortgage. In many cases the cost of living increase is unavoidable as many are everyday items and services. So, with the less and less income available to finance mortgage obligations the number of defaults will begin to rise and repossession sales start to emerge.
Flippers are everywhere
Those acquiring property with the intention of selling for a relatively short term profit are known as “flippers”. In the middle of a house price bubble there will be a constant flow of potential buyers and flippers will emerge from everywhere. It can be difficult to spot a “flipper” unless you regularly review your local property news and know which properties are being resold. There is nothing wrong or nothing illegal about flipping investments but it can indicate a house price bubble – demand at any cost!
Creeping interest rates
Since the 2008 US mortgage market collapsed, leading to a worldwide economic downturn, we have been living in a historically low interest rate environment. This has created a constant flow of cheap finance leading to increased demand for housing assets. Lately, we have seen US interest rates start to edge up, suggestions that UK rates will follow and eventually others central banks will be forced to follow. Interest rates are a relatively basic tool used by governments and central banks to control the flow of finance. This can have a dramatic impact on property markets as higher interest rates mean higher mortgage payments. Those who acquired property at the edge of their financial reach when interest rates were low will be squeezed as interest rates begin to tick higher.
Conclusion
Investor sentiment and the “feelgood factor” can feed a housing market, pushing it to levels which are quite frankly unsustainable. Gradually rising interest rates will squeeze finance, cost of living increases will affect household budgets and relatively high leverage rates can put homeowners on the edge of the precipice in the event of even a small increase in mortgage repayments. As soon as defaults begin to emerge and repossession sales become more commonplace the house price bubble is quite literally ready to pop.
When investing in property you should always sit back, study the numbers and use traditional measurements to clarify whether a property is undervalued, fairly valued or overvalued. Yes, you may miss out on some profits as the froth begins to build before the house price bubble pops. However, you will live to fight another day and a gradual increase in your property portfolio with a long-term view in mind will be far more lucrative.