Global Housing Market Declines and New Policies: Key Takeaways

Around the world, economies that have historically been real estate-centric are witnessing a significant shift: house prices are falling. This trend is evident in China, where real estate, once the world's largest asset class, has seen consistent declines for 36 months. Canada has experienced over 20% drops in some cities, and New Zealand's inflation-adjusted market is down by over a third in major urban centers. These downturns are arguably more impactful in these countries than in the United States, given their economies' deep reliance on real estate investment.

For the past two decades, there was a prevailing assumption that governments would intervene to prevent substantial drops in house prices, fearing a full-blown economic crisis. Government actions often reinforced this, with policies ostensibly aimed at affordability often making housing more expensive. However, this paradigm is changing. Many governments are now actively working to cool down their housing markets.

Global Policy Shifts

• China: Implemented strict financing regulations for property developers.
• Canada: Is loosening zoning restrictions and tightening migration policies.
• New Zealand: Has reduced building restrictions, even as its market declines.
• Australia: Recently passed sweeping tax changes, including phasing out "negative gearing" on established properties and overhauling capital gains tax discounts, which previously incentivized speculative real estate investment. These changes aim to reduce the appeal of housing as a purely speculative asset.
• United States: Passed a bipartisan housing affordability package, addressing long-standing issues in the housing market.

These policy changes are generally seen as positive, especially for younger generations who have felt priced out of homeownership. However, they raise a critical question: if the housing market was considered "too big to fail," what has changed, and who will bear the cost of this policy reversal?

Distinguishing Between Types of Housing Market Declines

It's crucial to differentiate between an economic crisis causing falling home prices and falling home prices causing an economic crisis. Historically, politicians have been reluctant to implement policies that could lead to homeowners being underwater on their mortgages or impact the investment portfolios of older generations. This led to demand-side policies, such as low down payments, co-signing options, and extended loan terms, which inadvertently pushed prices higher, benefiting existing property owners.

Today, many countries are experiencing house price drops exceeding those of 2008, with policies actively contributing to this trend. Industry groups are voicing concerns, arguing that governments are exacerbating an already weak market and potentially leading to another major crisis. To assess these claims, it's necessary to examine the new policies in detail and observe the outcomes in countries further along in this process.

The 21st Century Road to Housing Act in the US

The recently passed 21st Century Road to Housing Act in the US received overwhelming bipartisan support (358-32 in the House, 85-5 in the Senate). Despite political maneuvering, the bill is expected to become law due to its veto-proof majority. This legislation introduces significant changes to the housing market:

1. Incentives for Looser Zoning: The Department of Housing and Urban Development (HUD) will offer grants to local governments that ease zoning restrictions to allow for more dense housing development. This addresses a long-standing call from housing economists, recognizing local zoning as a national supply crisis. Houston, with its more relaxed zoning, serves as an example of how this can lead to more affordable housing.
2. Streamlining Regulations for Manufactured Homes: The bill significantly reduces red tape for small, factory-built homes by eliminating the permanent chassis requirement. Previously, manufactured homes had to be built on a metal frame with wheels, even if they were never intended to be moved. This change is expected to reduce the cost of each manufactured home by $5,000 to $7,000, a meaningful discount for entry-level housing.
3. Restrictions on Investment Firms: Corporate investors owning 350 or more single-family homes are now prohibited from purchasing additional ones. This aims to reduce competition for individual homebuyers and redirect capital towards multi-family developments, increasing overall housing supply.

These changes are designed to increase housing supply and affordability. However, they are being implemented at a time when housing prices are already falling in many US markets.

Current Market Dynamics in the US

As of May, national list prices were down 2.4% year-over-year, with declines in 41 of the top 50 metro areas. The West Coast and Sun Belt, which experienced a pandemic-era construction boom, saw the biggest drops. Several factors are contributing to these declines:

• Interest Rates: Mortgage rates have tripled since the housing peak, reducing buyers' borrowing capacity.
• Migration Patterns: People are moving out of pandemic boom cities and back to urban centers with job opportunities.
• Insurance Costs: Home insurance premiums have become a major hurdle, particularly in regions like Florida and Houston, where annual costs can reach $8,000. High insurance costs reduce a household's ability to afford mortgage payments and can make homes effectively unsellable to anyone but cash buyers. The "surplus lines market," with higher premiums and weaker consumer protections, has grown significantly in these states.
• Institutional Investor Exodus: Large institutional investors, anticipating a market correction, have become net sellers of single-family rental homes. In Dallas, for example, investors are responsible for nearly a quarter of all new for-sale listings despite owning only 9% of the housing stock.

While current price drops are not catastrophic and most areas are still up compared to pre-pandemic levels, the combination of these market forces and new supply-side policies could further accelerate price declines.

Is Falling Housing an Economic Crisis?

The question of whether falling house prices constitute an economic crisis depends on the underlying causes. If prices fall due to increased housing supply meeting demand, it indicates a healthy market. Denver is an example of this, with home prices and rents declining due to sufficient new construction, offering more options for buyers and renters. This type of decline is generally positive, as it makes housing more affordable and creates employment in construction.

Conversely, if prices fall due to economic collapse, like in Detroit after de-industrialization, it signifies a crisis. In such cases, falling prices are a symptom of broader economic distress, not a solution to affordability.

The 2008 financial crisis was an exception, not the rule, for housing corrections. It was caused by structural problems in the financial industry, where reckless speculation using bundled "garbage mortgages" as collateral led to widespread losses. The housing market was collateral damage.

The current fear-mongering about falling house prices often comes from groups with vested interests in maintaining high asset values. It's important to recognize that housing, when viewed purely as an investment, has benefited from accommodating government policies for decades. Therefore, it should also be exposed to the risks of government intervention.

Who Pays the Price?

Falling house prices become a significant economic problem when:

• Individuals are overleveraged in housing.
• The financial system uses housing as collateral.
• Other economic sectors depend on rising housing values.

Currently, all three conditions are present to some extent. The most vulnerable are recent homebuyers with minimal equity, especially those who purchased in the last two to three years with high interest rates. A 10-15% drop could leave them underwater. This situation is exacerbated by past policies that encouraged homeownership with minimal down payments, leaving little safety buffer.

While a catastrophic drop similar to New Zealand's major cities (over a third from peak) would still only bring US prices back to 2021 levels, it highlights a dilemma: prices have grown so much that even significant drops may not make homes truly affordable.

Ironically, young people, who are most likely to be hurt by recent purchases, are also the most supportive of these policy changes.

One often-overlooked sector that could be significantly impacted is aged care. This industry has grown by leveraging the equity in seniors' homes to fund end-of-life care. Reverse mortgages, cash-out refinancing, and selling homes to pay for facilities have been common. Aged care facilities, often heavily leveraged themselves, have relied on a steady stream of homeowners with appreciating assets. A decline in home values could disrupt this model. While some might not mourn the loss of "easy money" for this industry, it's worth noting that aged care is a stable source of employment in many smaller communities.

More broadly, falling home values can trigger a "wealth effect," leading to consumer pessimism and reduced spending. For many American households, their home is their primary wealth, and unlike stocks, it cannot be partially sold to cover expenses.

Most economists do not predict a 2008-style collapse from these policy changes. Lending standards are better, securitization risk is lower, and underlying housing demand remains strong.

Lessons from Other Countries

Other countries that have already implemented similar policies offer insights:

• China: Despite its housing market being arguably more central to its economy, and experiencing a severe crash since 2020 due to the "three red lines" policy, the Chinese economy is recovering. It's now driven by more sustainable industries like high-end manufacturing and exports, rather than speculative real estate. While not painless, it did not lead to a global financial crisis.
• New Zealand: After years of an overheated market, the government cut building restrictions, raised interest rates, and adjusted tax concessions. Inflation-adjusted prices in some major cities dropped by over a third. Further reforms, like allowing granny flats without building consents, have led to a 10-year high in housing inventory and a buyer's market.
• Canada: The Canadian housing market is also experiencing a downturn, with condo prices down nationally and significant unsold inventory in cities like Toronto and Vancouver. While policymakers are showing some "cold feet" (e.g., a program to buy unsold condos and convert them to affordable housing, which some view as a developer bailout), the market is still adjusting.
• Australia: Is phasing out "negative gearing" and overhauling capital gains tax discounts to reduce the incentive for treating housing as a speculative investment. These were once considered untouchable policies.

It's important to note that, outside of China, these countries' economies were already slowing before their housing corrections, making it difficult to isolate cause and effect. However, the experiences of these nations suggest that significant housing market reforms, even with price declines, do not necessarily lead to catastrophic economic collapse, and can even realign economies towards more sustainable growth.