I wrote an article titled "Buying a home: It may not be your best investment" in Apr 2018 out of frustration from trying to dissuade some friends from investing in the UK housing market. Some of them were chain buyers piling upon multiple mortgages. I was laughed out the room for being an obvious "village idiot" when I said that putting all the eggs in the same basket was a terrible idea. Housing is always a safe bet, they reminded me. I recommend you read that article, if you haven’t done so already, as I believe it is still very relevant today.
Now as COVID-19 brings the economy down to its knees, the housing market is poised for a significant crash. It’s just pure speculation or just wishful thinking to make comments like - "even if it crashes, it will come back up quickly", "once the economy recovers, the housing markets will be back up too", "it will bounce back just like 2008, it always does”.
That might all be true, but this is probably not the time to bury your head in the sand and hope everything will pass. Sure, it will but it might not replay exactly like what many of us may have learned from the past. And I am back here on reddit to call 'the emperor is naked’ once again; housing is not a safe bet and hopefully nudge some of you to be prepared to face the reality.
I first started looking for a house in South London in late 2015. My wife and I earn reasonably well but we were quite surprised when we realised that our savings were not enough to put a 10% deposit against even a mediocre flat. The dream home was always just a "few more dollars" away. In early 2016, the craze of home buyers was just so overwhelming that we almost decided to get some financial help from our parents. Luckily at some point during the property viewing spree I had an inkling that something wasn’t quite right. Too many people were turning up to view every single property. It was disheartening as they bid up the prices beyond our reach. So, I went back to the books to find out what the heck was going on.
I quickly realised that everything about the housing market was wrong. The historically low interest rates, incredibly high loan-to-value ratio (up to 95%), help-to-buy schemes and the subsequent craze and the stampede that followed; it was a bit like what I later read in "Extraordinary Popular Delusions and the Madness of Crowds” by Charles McKay. The property prices in many parts of UK reached sky high that it couldn't be pushed up any further as there were no more buyers who could afford them at sensible valuations. The easy money policies had swindled people (and corporations) into borrowing like there is no tomorrow. Mortgages, car loans, credit-card loans, student loans, business loans - all these have to be paid back with the income generated within the economy that is already bogged down by a big pile of debt, highest in the recorded history and still growing.
COVID-19 is a fat-tail event, rarer yet not as unlikely as assumed, that tipped over an already weak and exhausted market into a quick but painful reality that should have gone down at some point anyway. The lenders are pulling out of the markets or are being extra cautious; they aren't sure if they’ll ever get back their money. As numerous businesses are expected go belly up or to see their revenues drastically reduced, many are going to lose their income or find it severely clipped. The people who never bothered about saving for a rainy day will now seriously consider it. In other words, there will be very little spending in the economy. Remember that one person’s spending is another person’s income.
The falling income across the board creates a ripple effect through the economy leading to the "velocity of money" to fall; i.e., the money flowing through the economy becomes sort of stuck. People soon start defaulting on the mortgages, car loans, credit card loans etc which further exacerbates the situation creating a feedback loop. Since "money is debt", every default lead to more money disappearing from the economy. If that’s too complicated to comprehend, watch Ray Dalio’s "How the Economic Machine Works” on YouTube.
Less money in the economy, just like any other commodity, makes it dearer. Its value against everything else goes up; i.e., price of assets come down. In 2008, the central banks had enough room to lower the interest rates and indirectly push people to borrow more, thereby creating additional debt/money that could be used to service (payback) existing loans. This new money had triggered more spending that boosted the asset prices. But now with the interest rates almost touching zero, that option can be pretty much be ruled out.
It looks like the government has a couple of ammunitions left - a) bring down taxes and b) do more quantitative easing (printing more money) with the possibility of "helicopter money” (ie., paying people directly into our bank accounts). And hope that we’ll all start spending again as we used to do before the crisis. But with the deflationary pressure so high, worsened by the human psychology to hoard as much as possible during uncertainties, it will take a while before things start working again.
Bear in mind that these government policies are a double-edged sword - if the flow of money in the economy (the velocity) picks up too quickly, inflation could easily get out hand and lead to a run on the currency. A currency devaluation would be met by higher interest rates by the markets as no lender would like to get back less than what they lent out after the repayments are adjusted for inflation. This would mean that borrowing might become less attractive and affordable to new home buyers and also to the existing mortgage holders who are on variable rates. This would put more downward pressure on the housing market. Remember that the price of an asset is only what another person is willing to pay.
Now IF the government decides to devalue the currency to such low levels, the price of all services and commodities could go up along with the houses. We could see some stagflation or even a hyperinflation of the currency. Homeowners would be richer again but only nominally but not in real terms. In other words, a house in South London may not buy the same number of cheeseburgers in the future as it did in early 2020.
Also, there are quite a few proponents of the "end of fiat money system", especially the gold/bitcoin bugs. There are some very interesting case studies on why there have to be a new monetary system that ought to replace this current debt based “Ponzi" one. I do not disagree, and it might be wise to hedge some of your risks if you think so. But from a bird’s eye view, between "crashing the currency and thereby putting the sovereignty in jeopardy" vs "blaming the god-sent COVID-19 for everything and let the asset prices crash", I think the latter might be a much obvious choice for the governments to make. A few months from now BBC can run an article titled “COVID-19 crashes the housing market” and the government could wash their hands off.
Either way, as the smoke clears up, I believe it is likely that we might see some great buying opportunities for those who had been waiting on the side-lines. But at the same time, I am more worried about a currency crisis than a housing crisis at the moment. Although cash should be the asset to own in a deflationary environment, central banks have unleashed their printing presses to fight deflation. It is going to be a heck of a fight and ultimately the central banks will be the obviously winners (if they wish). But how it unravels and how long will it take is what I, if not taken out by COVID-19, am anxiously trying to make out. Meanwhile, I stay put on my relentless wait...
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