How a Decline in Economic Growth Affects Property Markets - Research Paper Example

How a decline in economic growth affects property markets, using examples from housing sector Context: The construction industry is one of themain indicators of economy and contributors to the GDP. Hence slowing down of it could take the economy to recession. The present article is an effort to see the impact of one of its main sector, housing sector, on national economy at this time of slump. The attempt is to seek answers to questions viz. What led to fall in housing prices, are mortgage arrears and repossessions increasing, what is the attitude of banks towards borrower in this time of economic downturn Since housing is the basic need of human life, the discussion also focus on social impact of resulting unemployment and debt on family life and children. Theme 1: Economic Downturn and construction Industry The Rise and Fall of property Industry: An Overview The costly credit and impact of inflation made retail suffer badly in 1990. In the major UK cities low income people hindered from entering into property market due to high interest rates.. As a result there was overall slowdown in the activity. There was decrease in institutional property investment and returns reduced on retail investments. Schemes for new large stores were shelved or even cancelled while existing store outlets were scaled down or closed in a bid to attract larger customer share from competitors. The picture was total contrast from the 1980s when companies invited the big names in retail developers to design unique themed malls on latest retail and leisure ideas (Jacobs 1992:93). Thus the slump of property and construction industry provided an example as to how fast the market led growth falls. The recession affected even the most promising construction schemes as their ratings were down and billions were wiped off the share portfolios. It was a blow to Thatcher's vision of a Homeowner's nation. (Jacobs 1992:94). Jenkins (1991 as in cited in Jacobs 1992) finds a cyclical nature of UK property industry. He studied the property market from 1960 and found that there was increased involvement of banks and pension funds with the property market. However pension funds were withdrawn after 1984 on account of less liquidity of property compared to the equities. The property was then presented by developers as security to obtain bank loans (Jacobs 1992:95). The multinational companies have integrated the economies of different countries and changes of one nation are transmitted to other. At the same time there are more stable interest rates and low economic volatility. But the low inflation puts the lender at a risk of default while borrower may have some advantage ( Forest and Lee 2003: 163). The property companies were also helped by the bull market which increased their funds needed for development. By 1991, the overseas banks had 43% funding of property industries. The property slump occurred as a result of entry of foreign capital which made this sector vulnerable as it was dependent on borrowing (Jacobs 1992). The current slump in economy has affected the construction industry as can be assessed by a comparative account of construction and GDP. The latter is the most important indicator of a nation's economic health but likely to decline by 2.9 per cent in real terms over the 2009 (The Centre for Economics and Business Research (CEBR)). It will be the biggest annual fall since 1946 when the country faced mass de-mobilisation after the Second World War. It is forecast that industrial investments may decline by more than 15 per cent in 2009 and pose the biggest risk to the economy while household expenditure is expected to come down by 1.8 per cent in the Year. Theme 2: Factors currently influencing housing sector: Was fall in prices long overdue: The issue is that house prices started to fall even before growth started to slow down. In other words there are many microeconomic factors reducing house prices. Therefore, the fall in economic output has aggravated these other factors that are now causing lower house prices. In 2007 the housing prices were six times the average income thus well above the long term average of 3.8 times (Fig. - 1 as cited in Williams & Hussey 2008). The ratio of house prices to rent and the average mortgage payment as percent of average income has been to the highly stretched levels (Fig. - 2 as cited in Williams & Hussey 2008). The latter caused affordability much dearer however with slumps in housing prices the affordability is likely to increase.. The housing sector could only come down from there and that is what happened. Fig. 1. Fig. -2 What is the future of UK Housing Sector: A speculation from previous economic downturn hints a low residential investment and increasing unemployment. The latter affects rising arrears and repossessions. But compared to previous downturns the country is better able to keep employment loss much lower. Thus reducing the severity of blow to the housing sector. However it is the mortgage market which may create problem for the housing sector. The bank of England data show the mortgages are costlier now and also harder to get approved. It particularly puts off the first time buyer and increases arrears and repossessions while at the same time decreasing the house prices. The mortgage arrears may rise to a peak 3% while the repossessions to 0.45-0.50& in the 2009-10. It still is much lower than almost 7% and 0.8% increase of these, respectively of the early 1990 downturn (Fig 3 as cited in Williams & Hussey 2008)). Fig. 3 The housing sector is not yet saturated in UK. It is only 3.9% of the GDP compared to over 6% in European nations and US. The sector is unlikely to have collapse though a setback is certain affecting the national economy. A 30% drop in housing investment would reduce nation's economic growth by one point. The share of residential investment in GDP would be record low. What is making banks reluctant for loans : Bank loans are biggest source for buyer to fund for a house. If a price fall in housing is around 15-25%, increase in unemployment to about 7% and mortgagee rate of 5% , the banks may lose 5-20% of their profits. Banks with business outside UK and those out of mortgage market would be protected from housing sector's downturn. To some banks which have risky mortgage business viz. Subprime and self certified interest will suffer badly. These mortgage types were not in existence during 1990s but now are nearly 11% (Fig. 4) (Williams and Hussey 2008). The housing investment is a big contributor to economy and its slowdown would affect other related businesses of banks also. For e.g. credit card landing would suffer. Retail and real estate are affected by decline in housing investment and would reflect on less corporate lending by banks. Fig. 4 The housing sector in England had done well because of easy and cheap loans. However the rising inflation has made it difficult for banks to cut interest rates, as a result the housing sector is badly exposed. Theme 3 Social cost of recession Children and Broken homes : There is prediction of recession in UK in the coming year. Everybody is concerned about economic consequences of recession. Recession also has a human cost. Financial troubles and a build up of personal debts lead to family break ups. The children are the worst sufferers in a family breakdown. The studies show alarming consequences on them. A child from a broken home is 75 per cent more likely to fail at school, 70 per cent more likely to be a drug addict and 40 per cent more likely to have serious borrowing problems. There are fewer life choices to children and most lead to crime , failed education and financial dependence (Smith 2008). He further aggravates the problem by referring the report of 2007 claiming 11 million people suffered broken or strained relationships due to debt. The solution to such situations is not in the sight to these families, as they do not realise that their problems are brought by the financial difficulties. Even before the downturn the pressures of debt started problems for the families. The scale of this personal debt is disproportionately large in Britain compared with other European countries. In 1997 personal debt stood at some 430 billion; last year it had risen to nearly 1,200 billion. During the recession the debt becomes a bigger problem because of high interest rates on credit cards and mortgages as lenders may charge anything from 180 to 500 percent interests. The debt spiral not only has a direct cost on family ,it has links to crime as well. The aggression leading to physical assaults with knife and gun increase to about 20%. Otherwise also the gangs related with such violence include children grown up in social housing and more often in broken families both of which are major causes of unemployment among youth. The economic downturn further aggravates this condition. Unemployment: The economic downturn sharply increases the unemployment The unemployment rate was 6.0 per cent for the three months to October 2008, up 0.4 over the previous quarter and up 0.7 over the year. The last time the rate was higher was in the three months to May 1999 (when it was 6.1 per cent). The number of unemployed people increased by 137,000 over the quarter and by 238,000 over the year, to reach 1.86 million (the highest figure since the three months to December 1997).(Unemployment, 2008). The sharp fall in economic growth and consequent rise in unemployment will have the effect of further depressing house prices and demand for buying houses. Conclusion: Construction industry is one of the important contributors to the GDP of a nation. Housing sector of this industry is not only has economic importance, it is also necessary for society's well being. The current economic down turn does not seem to be over as yet. The house prices are liable to keep falling for the foreseeable future, perhaps bottoming out in 2010. This reduces the effectiveness of expansionary fiscal and monetary policy to bail out this industry at least for the time being. The article has discussed the factors that have resulted in the boost to this industry and also those which caused a decline over a long stretch of time. A brief mention of most important aspects is presented to conclude the discussion. Increased risk occurs when there is unemployment or fall in housing prices. The fall in house prices creates residual debt. These affect particularly the households with mortgages. As a result the house prices fall along with decrease in demand for new houses. There is rise in arrears and repossessions. House prices further fall as there is forced sell and increased supply of houses. Moreover, those still employed would defer the big expenses such as a house till economic condition improves. The problem is of mortgage credit to first time buyers. It is not only the banks who are reluctant to lend because of negative equity, the consumer also hesitate to mortgage a house for the same reason. The collapse of housing sector by fall in prices can lead to recession. The reason is that at the time of economic upturn, the consumer is spending and borrowing more and saving less. Consumers remortgage their houses to withdraw equities to spend. There is lot of money in the market (Liquidity) leading to more construction. When there is economic downturn, These factors are reversed. The consumers spend less and there is recession in housing market. There is though a ray of hope, to some, in the times of low economic growth. The interest on mortgage payments is reduced making buying of houses rather attractive while reducing the repossessions to some extent REFERENCES Centre for Business and Economic Research (CEBR). Viewed 8 Jan 2009 at : www.cebr.com Forest, R. & Lee, J 2003, Housing and Social Change: East-West Perspectives, Routledge Jacobs, B D 1992, Fractured Cities: Capitalism, Community, and Empowerment in Britain and America, Routledge. Smith, I. D. 2008. Effect of recession; The impact of debt on society. The center for social Justice. Viewed 9 Jan 2009 at http://www.centreforsocialjustice.org.uk/default.asppageRef=275 Unemployment. 2008, Statisctics.co.uk, Viewed 9 Jan 2009 at: http://www.statistics.gov.uk/cci/nugget.aspid=12 Williams, DS. & Hussey, S. 2008, Will Falling House Prices Undermine the UK Economy and Banks Viewed 8 Jan 2009 at::www.abglobalwealthmanagement.com/CmsObjectABGWM/PDFs/Housing_ Market_FINAL.pdf Read More