While there are economic challenges right around the world there are still a number of property markets which seem to be overstretch. Even though London, as one example, is starting to slow it has been one of the best performers around the world and on traditional valuation methods it has been stretched for many years. By definition a house price bubble which is about to burst occurs when you least expect it. So what are the five signs of a house price bubble?
Cheap finance
One very common element of a house price bubble is the availability of relatively cheap finance. It is fair to say we are currently living in unknown territory with worldwide base rates near historic lows, cheap finance readily available and everybody seemingly waiting for the troubles ahead when interest rates eventually increase. As we touched on above, house price bubbles rarely burst when you expect them but there is no doubt that cheap finance is still readily available and will be for some time to come. Whether property buyers will be able to afford payments as and when mortgage rates increase remains to be seen.
High degree of leverage
Recent changes to mortgage regulations have increased the deposit requirement which in turn reduces the level of leverage available. In years gone by it was possible to obtain a 100% mortgage, in some cases a 120% mortgage, which effectively meant acquisitions were financed purely by debt. This works perfectly in the good times but when markets turn and asset values dip below mortgage liabilities this is when the trouble begins. While deposit requirements are still relatively high compared to years gone by, some mortgage providers have started to slip back into their old ways.
House prices rising faster than wages
We know that both house price inflation and cost of living inflation are both significantly greater than wage inflation. This means that the relative value of the pound in your pocket is slowly but surely being eroded. Over the last few years we have seen a number of buyers in the UK stretching themselves to their financial limit with house price value to income multiples extremely high in some areas. If the economy was to take a dive, wage inflation was to fall and unemployment was to increase this could in some circumstances burst a house price bubble.
Overseas investment starts to fall
Sometimes it is easier to see potential problems in a property market if you are on the outside looking inwards. In some house price bubbles we have seen a reduction in overseas investment as markets start to get stretched and look as though they are heading for difficulties. This pattern is not always followed by domestic buyers who tend to focus more on their local markets and are often blind to what is actually occurring. We are unlikely to see any major reduction in overseas investment in the UK, as one example, in the short to medium term because of the fall in the currency against the likes of the dollar and the euro after the Brexit vote. So, while traditionally a reduction in overseas investment could point to a potential house price bubble about to burst this is not always the case.
Interest rates
As we touched on above, historically low interest rates around the world have led to a deluge of cheap finance which has allowed many investors to acquire properties which may traditionally have been out of their reach. In the UK for example, the base rate recently increased to 0.5% having been stuck at 0.25% for the last decade. This is not necessarily a big jump but the increase is likely to be passed on in full to variable-rate mortgage holders. As UK interest rates begin to tick higher, predominantly to combat inflation, this will increase mortgage payments, reduce household expenditure and have an impact upon short to medium term economic growth. It is fair to say that we are approaching this stage in the UK and many people who signed up to relatively low mortgage rates will start to feel the pinch as rates tick higher.