What factors are contributing to the rise in global property prices? Well, it's all about the money. This is a condensed version of the findings from the study conducted by the Bank of International Settlements (BIS). The Bank for International Settlements (BIS), which is known as the central bank for central banks, recently issued a warning the risks to global home prices are being formed. According to the findings of their researchers, the majority of the progress made since 2020 can be attributed to monetary policy. A synchronization risk was created as a result of countries adopting policies that were similar to one another. These risks have the potential to become a significant threat to the economy if higher interest rates and less leverage are not implemented.

Gains in Global Real Estate Price are Unusual

It appears that the majority of people are under the impression that real estate prices go up when interest rates go down. When the first signs of a recession appeared, it was obvious that this was an excellent time to purchase a house. Before the most recent economic downturn, this was never the situation at all.

In the past forty years, when the economy has entered a recession, home prices have followed suit and fallen. The researchers discovered that this decrease, which follows an economic shock, typically lasts for four quarters. Home prices shot up during the pandemic and completely disregarded the slump that was occurring at the same time. The researchers wrote that there was not even a temporary drop, and the tone of their writing almost sounds shocked.

In addition, a phenomenon known as credit contraction took place during this most recent economic downturn. Or, more specifically, an insufficient amount of credit contraction. In times of economic hardship, individuals typically cut back on the amount of debt they are carrying. However, rather than taking a step back, central banks poured massive amounts of liquidity into the market. They flooded the market with cheap credit, which led to an increase in the number of liabilities being carried. It's possible that this was the only recession in history from which households emerged even more financially stretched than before. It would be understating the extent of how unusual this path was for home prices during a recession.

Global Home Prices Surged As Easy Money and Investors Flooded The Market

According to the study, global real estate prices increased for several reasons. After the caused recession, economies recovered far faster than projected. There were few opportunities to spend your spare money, therefore household savings surged. The financial aid was helpful, but its overuse may have produced a moral hazard. Supply chain constraints are real, and they might contribute to inflation. Even so, none of these factors had much of an impact on housing values when compared to... anyone? Bueller? Bueller?

That's correct, it's easy money. The idea essentially consisted of flooding the financial sector with cheap and easy debt. Some people made educated guesses at first and didn't make any modifications until two years afterward. To call it imprecise would be an understatement. Housing demand soared in most Western economies as a result of the cheap money.

“Above all, exceptionally easy financing conditions have boosted demand for housing further amid the strong liquid asset positions of households and support from other factors,” the researchers wrote.

“Households looking to be owner-occupiers can borrow at historically low nominal and real interest rates. In addition, gross rental yields are well above bond market returns in AEs, turning dwellings into attractive assets, including in the buy-to-let segment,” explains the researchers 

Cheap loans didn’t merely stimulate owner-occupied home sales, as per the narration. Investors recognized an arbitrage opportunity to take a loan at low rates and transform it into rental yield. It’s an element of yield hunting, a practice that skyrocketed in growth during the Global Financial Crisis (GFC) (GFC). Due to low market bond rates, investors were obliged to convert Millennial rent payments into regular payments.

Following the 2020 Rate Cut Extravaganza, the investor tendency accelerated. Investors now account for more than a quarter of house sales in countries like Canada. A quick search on TikTok reveals a plethora of popular accounts detailing how to make real estate investments. How could they leave this chance?

"The inflation-hedging features of housing may also have had a role," the BIS says. In the late 1970s and early 1980s, this was a popular housing strategy. Some people were fortunate in escaping rising inflation and interest rates. Normalization of inflation quickly turned the bubble into a disaster. Let us now turn our attention to dangers.

Synchronization of global real estate prices is usually bad news.

Global synchronization of property prices was detected by BIS analysts, which is never a good omen. We've discussed synchronization previously, but the point is that it occurs when assets begin to behave similarly. It's characterized by a non-productive economy with plenty of cash but inadequate parking spaces. Everything inflates when there is so much money that can't be navigated properly. In this situation, it makes no difference if the home is in a suburb or a city, Vancouver or Poughkeepsie, because values are growing.

When it comes to financing, synchronization nearly always equals increased risk. When assets share the same driver, they tend to behave similarly. It's the polar opposite of diversification, which spreads risk and reduces damage. Synchronization converts an asset group into a cascade of dominoes, each one waiting for the next to fall.

“… the international synchronization of house prices has strengthened. More than 60% of house price movements can now be explained by a common global factor. One reason for this much higher synchronization is that the pandemic has been truly global, thus inducing similar policy reactions and flattening yield curves worldwide,” wrote the researchers.

In other words, property values in these areas were driven by monetary policy. It wasn't local characteristics that created identical situations, but rather similar policy responses. This is a similar problem to what we've seen with inflation. While global circumstances have played a role, countries that have followed comparable strategies have fared worse.

Global Real Estate Risks are Increasing Rapidly

Transitioning from this bubbling atmosphere to one that is more stable, according to the BIS, will be difficult. Growth risks are increasing, and they can manifest themselves in one of three ways:

1. Home prices level off as household incomes rise.

It isn't feasible in markets like Canada, where costs have increased by more than 50% since 2020. If property values remain stagnant, markets with only a minor disconnect will most likely ride it out. Thus the economic consequences would be minor.

2. The house pricing boom continues.

Inflation would have to slow dramatically in order for interest rates to fall. In the near term, this would be beneficial, as it would promote the construction and the economy.However, it would exacerbate speculative demand and resource misallocation, resulting in more serious problems. If Canada followed this path, Capital Economics recently predicted that a little correction would evolve into a major crash. It also runs the risk of throwing the country into financial chaos.

3. There is a significant and rapid reversal in home prices.

If inflation rises in tandem with interest rates, home prices will reverse sharply. This would include monetary tightening and financial excess unwinding. It's the worst-case scenario, and it usually happens when interest rates are gradually increased.

Higher rates and Less leverage will pop the Global real estate bubble

Higher rates and lower leverage, according to the BIS, provide the best results. They offer two plans: tax policies to deter speculation and debt-financed ownership. The combination would lessen the need for a market-driven correction. Countries such as Canada have already stated that they will do the exact opposite, embracing more demand-driven policies.

The United Kingdom has joined Canada in defying all logic. A Canadian-style leverage plan for buyers is being considered in the United Kingdom. It would result in taxpayer-backed high-ratio loans, reducing lender liability. There is no obvious problem in protecting lenders from the consequences of disastrous high-leverage loans.

Central banks may save the day, despite policymakers' best efforts to manufacture the worst possible outcome. Please, don't laugh. Keep in mind that these solutions are developed by the "central bank for central banks."

In addition to stabilizing inflation, gradual rises in interest rates could help curb housing market excesses and mitigate tail risks. Maintaining expansionary policies for longer may help to stabilize demand in the face of higher short-term uncertainty, but it may also exacerbate vulnerabilities, according to the researchers.

To put it another way, boost rates above the terminal rate to avoid the worst-case scenario. The greatest strategy to prevent the market from becoming overly leveraged is to reduce leverage gradually. Who knew?