Comment on recession

A recession doesn't mean house price deflation but it can be a root cause. Access to credit may become harder, as lenders become risk adverse. They become more conservative and tighten up policy, for example by limiting low deposit mortgages or even withdrawing from new lending. Consumer confidence drops and fears of reducing income, loss of employment, or the impact on house values causes inertia. Less people move or want to buy. Financial hardship - Businesses struggle either from lack of demand or costs of supply or both and start to fail. Unemployment rises - borrowers and tenants struggle to service their living costs. Savings are spent, arrears accrue, possessions rise. Lack of demand - properties come to the market and few are in a position to buy. There can be a quick buck to be made if you are buyer with access to capital to pick up property as, eventually, values and demand will return and increase as a new cycle starts over.

Most recessions don't last very long. A few quarters at worst. But, in my view, the one heading our way will be no ordinary recession. It has all the ingredients to deliver a severe and prolonged shock to the global economy. What will it mean for property prices? I think they'll fall sharply, possibly as much as 5%-10% in 2023. Some people say prices can't fall because there's not enough housing stock. That's true, but house prices are also a function of the availability of credit. And the days of insanely cheap credit are behind us. We can have high house prices and cheap credit, or lower house prices and more expensive credit. We can't have both.

The UK property market has been busy re-writing the economic rule book for a few years now. As all the financial indicators point to a downturn, the market seems to say “hold my beer” and promptly goes in the opposite direction. So, with a recession looming, will it do the same again? The main reason UK property is such a resilient asset class (to borrow a phrase of my investment adviser colleagues) is, like gold, there’s simply not enough of it. We’ve failed year-after-year to build enough new housing and so that chronic undersupply keeps house prices high as demand is always high. Unlike gold, however, property transactions have a third party needed in most cases: a mortgage lender. Here lies the Achilles heel of the market. If lenders reduce access to funds, like they did in the global financial crisis when you needed a 25% deposit to buy, then we see people's ability to buy fall away. That in turn ripples through the market as house price growth stalls and, in the worst cases, falls back. So a recession in of itself won’t directly impact house prices, but if lenders get concerned with rising unemployment, continued increases in living costs and interest rate rises, then they may choose to protect themselves by placing some limitations on their lending. That could see house prices affected; but there’s a lot of ifs, buts and maybes in there. Only time will tell.

One persons misery is another ones opportunity is the way I look at the principle of a recession. On the one hand you have increased interest rates, high inflation, potentially job losses on the horizon (many of the conditons for stagflation) and a large portion of the population renting without inflation-protected salaries. If they start struggling to pay their rent either due to purchasing power decreasing or landlords increasing rents due to their own costs increasing you will be start to see tenants defaulting and where possible moving back to parents, to friends or to cheaper accommodation. Landlords will then start defaulting due to being unable to pay their mortgages, which means foreclosures will start to increase. Highstreet lenders will start to restrict lending for fear of bad debt and thus borrowing will reduce. At this point the specialist lenders that lack deposits, and who need to lend to make money will create their own synthetic quantitative easing by reducing rates and increasing gearing. They need people to keep borrowing. This will therefore benefit the opportunistic investment landlord who can access cheaper rates with higher leverage to buy up both the distressed properties at auction or cherry pick properties that are for sale, creating an opportunity for a far higher profit thanks to reduced cost of debt and scale from being able to deploy funds to more projects due to less of their own money tied up in deposits. Now prices in general will fall if the above economic impacts cause landlord to need to sell their properties e.g. due to failure to keep tenants. As they will want to exit their positions quickly they may take less than they think it's worth, this process on a grander scale is what's going to cause the market to fall. A recession and a fall in property prices in my view are correlated.

Keep in mind that in the 2008 recession banks simply ran out of money to lend. Without the ability to borrow money the public couldn't buy houses even if they wanted to. The lack of supply of money lead to a huge fall in demand and therefore slump in prices. This time around the banks are better capitalised so they'll likely want to keep lending to reliable borrowers, especially when that borrowing is secured on a house. I think all these people waiting for some big crash in prices to buy a place could be scratching their heads as to why prices don't fall as much in 2008, if at all.

The property market is very much a function of the economy. If the economy slows down, the property market will do likewise. If the economy goes into outright recession, the property market will stall and outright price falls are not from impossible.