House prices survived the last interest-rate rise. Will they this time?

RISING BOND yields imperil government finances. They will also change the housing market. The interest rate on most American mortgages, after all, closely tracks the ten-year yield on Treasuries, now around 5% and the highest in two decades, German mortgage lenders price off long-term bunds, and so on in other rich economies. If interest rates remain high, let alone rise further, a confluence of factors could spell a long period of weakness for house prices.

After the last jump in borrowing costs, in 2022-23, the global housing market emerged remarkably unscathed (see chart 1). Even adjusting for the inflation of recent years, rich-world house prices are only 4% off their all-time high. True, a few markets have wobbled. In New Zealand, where the housing market entirely detached from economic fundamentals during the covid-19 pandemic, real home values have fallen by 25% from their peak. Germany’s housing market, usually boringly stable, has also slumped.

But many other places are seeing a housing boom of sorts. Australia’s real house prices are slightly higher than their pandemic peak. In the fanciest parts of San Francisco, the neighbourhoods where Sam (Altman), Jensen (Huang) and other AI moguls known mainly by their first name have homes, house prices are up by 20% over the past year. Some markets are even healthier (for owners) or more unaffordable (for buyers). Someone who had the foresight to buy a house in Portugal during the dark days of the euro-zone debt crisis in 2013 would now be sitting on an asset worth nearly 200% more in real terms.

No one knows the future path of interest rates. Yet investors worry about housing. In America housing-related shares (such as those of construction firms) have underperformed the wider market by 16 percentage points since June. UBS, a bank, reckons that next year British housebuilders’ profitability will fall to its lowest rate since the aftermath of the global financial crisis of 2007-09. Even in Australia, where seemingly nothing can topple the housing market, homebuilders’ share prices are 10% off their recent highs. Three factors suggest that the rich world’s housing market is vulnerable to higher rates: mortgages, household finances and supply.

Take mortgages first. Households entered the last shock unusually well insulated. During the pandemic many Americans refinanced into loans fixed at 3% for 30 years. Australians rushed to take out fixed-rate mortgages, which the central bank had in effect subsidised over variable-rate ones (thanks to a “term funding facility” which lent to commercial banks at rock-bottom rates for fixed terms). In Britain, by 2022 a small chunk of mortgage lending had fixed rates for more than ten years—something once thought to be about as likely as getting a high-definition photo of the Loch Ness monster. Those “fixes” offered protection as interest rates rose.

Mortgage holders have less protection today. In most countries for which The Economist could find reliable data, households have taken out variable-rate products, in the hope that rates decline. In Australia, the share of the stock of mortgages on fixed rates has fallen from nearly 40% in 2022 to around 5%. In Canada the share on variable rates has doubled from its level in 2020. Even in America, the land of the eternal mortgage fix, the portion of housing debt on adjustable rates is higher than in 2021. And those households that continue to fix their mortgages often do so for less time. Our estimate suggests that the average Briton who fixes their mortgage now does so for 2.4 years, down from a recent peak of 2.7 years. The decline in Canada’s effective fix looks much steeper.

The second crutch in 2022-23 was cash. During the lockdowns generous government handouts had left rich-world households with “excess” savings of some $5trn (or one-tenth of GDP back then). People complained about a “cost of living crisis” as prices and interest rates rose, but many of them could draw on this stash to make ends meet. Today those excess savings have been drawn down. According to research published by the San Francisco Federal Reserve, Americans burned through their $2trn pile by mid-2024. In the EU households’ deposits are now worth 67% of GDP, down from a recent high of 77%.

The third and final support for prices relates to housing supply. The interest-rate rises of 2022-23 followed a long period of exceptionally slow pace of housing construction (see chart 2). The wave of millennials who hoped to graduate from renting to homeownership had little choice but to pay up for what limited supply there was.

In the face of the higher rates of recent years, however, housebuilding in most of the countries in our sample remains higher than it was in the mid-2010s. Banks are strong and “YIMBYs” (who say “yes in my back yard”) have pushed local governments to relax planning rules. In the past five years America has added 7.3m homes, compared with 6.1m in the five years before that. In Auckland, the largest city in New Zealand, YIMBYish politicians have pushed the number of housing consents to 16,000 last year, a huge rise on the norm before the pandemic. The number of units for sale keeps rising, giving buyers more bargaining power. For the first time in years, housing may not be a one-way bet.■