Fundamental factors of House Price:
Housing market does not work precisely in line with the economic fundamentals. One clear example would be the price versus income growth.
Relating income with housing demand is a fundamentally flawed idea. Rather it is inversely related to cost of carrying debt. In that case the astronomical growth in house price compared to very low wage increase makes perfect sense. Stagnated income but lowering interest rate helped house price to boom.
Some of the important contributors to house price are -
- Economic situation and consumer confidence.
- Income stability and wage increase.
- Population growth.
- Cost of carrying debt.
- Supply of land and new housing.
- Yields from house – As an investment and the expectations of yield – A high yield or return expectation is the reason of house flipping.
Effected segments by a price drop:
Lower Government Taxes:
A serious drop in house price will inflict major pain in every level of the society. After the homeowners, first to feel the pinch will be the government. A reduction in tax will occur in each sector. Lower house tax, land transfer tax, capital gain tax, sales tax and many more – will be a damaging blow to the tax collectors.
Problem for Housing related industries:
If there is no benefit of renovating the house then a homeowner will be reluctant to go to a contractor for a quote. Apart from less tax it will also cause lower sales and lay-offs.
Faltering borrowers are a problem for the lenders:
Regardless of the loan being insured against any default by insurers or lower loan to value ratio – defaults are a serious problem for any lender.
Once house price fall under the loan amount – many homeowners will start to think about recourses. It may not lead to defaults but will increase pressure on lenders.
REIT’s will feel the heat too:
No one can escape the burn. So, any investment scheme tied to housing industry will have to see a drop in their demand, subsequently their prices.
Lower rental vacancy rate.
A price drop expectation will raise the number of sideliners and therefore naturally the rental apartments will see a sharp increase in demand. This demand will be short lived.
Effects on homeowners:
They will be no doubt the worst effected section in the society.
- A number of people buy their house with 5% down payment. A slight decline in house price will disqualify them to obtain a mortgage at the time of renewal. That will lead to a higher sub-prime lending followed by higher defaults.
- There are number of homeowners who take money out of their homes to start a business. Many small businesses will suffocate due to this.
- The home is the biggest asset a homeowner has. The lower price will produce serious stress and they will likely reduce spending.
- If possible then many potential sellers will suspend the sell. Instead of selling they will prefer to rent it and wait for the good time to return. In urban areas this can become a norm.
How Long it will last?
It is not possible to predict the duration of the event. We had a boom for more than a decade. The bust cycle has the potential to last a long time too. In US this has been going on for last five years and probably will go on for longer time.
We shall talk about the precautions another day.