There is a lot of hype on social media about an impending property market correction. Real estate experts forecast drops in house prices from 2 to 3% all the way up to 30%+. The reality is no one knows. The size and speed of a correction will depend on events in the broader economy. These will unfold over the coming 12 – 18 months.
I have found it interesting that some people naïvely think a correction will be beneficial to first time buyers. Or, that it will somehow create more housing equality.
The reality is, it will be the exact opposite.
Sure, there will be a few first time buyers who benefit. They will get a good deal. But if they can afford to do that at the time, they will already be well off.
Here is why a significant correction will create more housing inequality.
Who will a fall in house prices affect?
The answer is those who have no option but to sell. During real estate price corrections, those who can afford to sit on their hands, do so.
Very few people frequently trade real estate. Few people adjust their housing position like in the stock market. They don’t sell their house at the top of the market and then wait for prices to adjust and get back in. If you are selling property this coming year it is because you have no other option.
Homeowners with lots of equity are likely to be older and in a stronger financial position. There are two groups who must sell if things get tough.
Developers are in the business of building and selling property. When times get tough, they need to keep going. They must continue to sell, albeit at a slower pace but they cannot sit on “stock” units for long. They need to sell at a discount or rent it out.
But renting properties creates a whole host of other financial issues, especially in the UK. For example, they will no longer qualify for HtB, and they will need to pay VAT on construction materials. So, most developers will sell at a paper loss, rather than renting out a property.
Distressed sellers can’t afford the property they are living in for whatever reason. Like developers, for these owners the clock is ticking. They will need to sell and sell fast. A 30 day delay will be another mortgage payment which they can’t afford.
Who will be active in this market scenario?
Even in times of doom and gloom the market will still operate. There are still active buyers when the market retreats. There are always two sides to a market. Active buyers in this type of market are:
BtR Investment Funds
BTR investment funds are well capitalised. They buy whole blocks which they can control or large housing developments. They buy for long-term yield. The more prices decline and rents increase, the more active they will become.
Property underwriters buy property wholesale from developers – they absorb their sales risk. They then retail the properties in the open market at a profit.
Buy to Let Investors
Buy to let investors are well capitalised, they understand their markets well. They can move at pace. They will already have an established “team” of bankers, lawyers and agents they work with.
There is cost of living crisis around the world. But Asia and the Middle East are not as affected. At the same time, sterling has declined against the USD by 30% since 2014. The currency magnifies their buying power in a market correction.
First Time Buyers
There will be some first time buyers who elected not to buy in the heat of the market. They held off for a correction they thought might take place.
What do sellers do?
When property prices fall at pace, pandemonium sets in. Developers and distressed buyers need to sell fast. Who do they sell to?
Developers need to close out their positions. They need to sell a lot of property at speed to reduce risk and stay afloat. Do they put in place a sales campaign to discount for first time buyers as prices continue to fall? Or will they cut their losses and move on? Developers will move properties in volume. There are plenty of funds, investors, and underwriters willing and able to buy volume at speed. If developers sell all the leftovers of their scheme they can close the marketing suite. They can recognise their return from an accounting perspective. And they reduce their downside risk.
Distressed sellers will appoint property agents to sell their property fast. Who will the agent turn to once instructed? The nice young couple who they recently spoke to looking for their first home? Or the BtL investor they have sold to for the last 5 years, who can act immediately and buy with cash and worry about a mortgage after they complete?
Other Impacts – housing supply decline
There are also a longer term impacts people must consider. If prices decline developers don’t adjust their margins to compensate. Many landowners don’t sell for less to help more development for the greater good. Developers won’t build what they cannot sell. BMW doesn’t build cars there is no demand for.
It takes on average 2 years to get planning consent in the UK for large scale development. Then another 18 – 24 months to start completions. Slowing or stopping construction will have a 3 – 4 year impact. When developers do start construction again, they won’t do it speculatively. They will need to pre-sell 30% to 50% of their scheme – who do you think the buyers will be?
You can download our first time buyer checklist, here.