Alexander Gorgoni and Paul Buckley ‘17
Picture yourself living in a small to medium sized house that you purchased for a couple hundred thousand dollars. If the market prices skyrocketed and all of a sudden your house was worth over a million dollars, would you sell your house?
Currently, interest rates in the UK are at .5%, thus making mortgages extremely inexpensive. In turn, waves of buyers are flocking to England to take advantage of this, causing the property values to increase dramatically. To put it in perspective, over the past 10 years the prices of houses in London have seen a 90% increase (averaging over £500,000), compare this to the 38% increase that the rest of the UK has seen, with prices of houses averaging around £272,000.
Declining real wage (wages adjusted for inflation) over the past 6 years for Britons is also producing a level of income that can’t keep up with the rising housing prices. According to the Mirror, the average Briton’s salary is £26,500, while four in five new jobs are in sectors averaging less than £16,640 per week. Clearly this income to housing gap creates a problem as property prices are making it increasingly difficult for average citizens to purchase homes.
For property owners, a real fear exists that this could potentially be their last chance to cash in before the bubble bursts. Analysts believe the market has topped out and is on the downward spiral. Home sales from April to June were 21% higher than the same period in the previous year; analysts believe that we may be entering a panic selling period in anticipation of a bubble burst. Coupled with an exodus of sorts that is seeing Londoners move to the cheaper countryside, we’re looking at a situation similar to the Great Recession.
So, what are the economical issues that can result from this? In 2007 the US was caught in the midst a similar scenario, resulting in the housing market collapse that lasted until 2009. During the 3-year period, the US housing market lost over $6 trillion in real estate value as shown by the Case-Shiller index reporting an 18.2% decrease from the same period the prior year; the largest decline in the index’s history. The housing crash triggered the Great Recession and during this period consumer spending took a massive hit. During this time period, overvaluation of real estate led to the majority of homeowner net worth (specifically the lower/middle class) being derived from their real estate value. Now if we make the assumption that the scenario previously explained is currently present in London; that net worth is made up primarily of property value, then a massive decrease in home prices will kill equity, thus meaning less cash to spend throughout the economy. As previously stated, when consumer spending is cut at such a drastic rate, recession is almost imminent.
With London housing prices poised for a decline and the potential of economic recession lingering, it remains to be seen what UK banks can do to counteract any large, widespread ramifications.