Can this housing market crash be as sharp as the one in 2008?

Real estate markets are cooling down around the world as central banks raise interest rates in attempt to restrain inflation. Such changes bring unpleasant memories of the largest housing crash this century, that happened in 2008.

However, according to Neil Shearing, chief economist of Capital Economics, we shouldn’t believe this decline will be as sharp as the previous one.

The fast prices increase, especially in Canada, Australia and New Zealand, seen during the pandemic may seem similar to the housing bubble of the mid-2000s. Nevertheless, the reasons for them are very different.

Last time, the bubble appeared because of significant growth in mortgage debt caused by “lax regulation and loose lending standards”, particularly in the U.S.

“So when the bubble burst, homeowners were left with negative equity and they had to sell creating a self-reinforcing downward spiral,” – he explains.

But this time the reason for a housing boom was a possibility to get historically low interest rates, caused by the COVID-19 crisis.

Of course, when the Bank of Canada and other central banks start raising those rates, a key element of market activity will be eliminated.

Shearing says since the beginning of this year, average rates on new mortgages were up from 2.7% to 5.1% in Canada and from 2.9% to 5.9% in the U.S.

“We can see more and more signs that this borrowing costs growth combined with the expectation of further increases is already leading to significant declines in real estate markets across advanced economies,” – he noted.

According to Capital, there are four stages to a housing downturn. At first, real estate market sentiment weakens. Then buyer traffic goes down, followed by a decline in mortgage approvals, sales and starts. And after that, the prices start going down, as well.

It looks like Canada, the U.S., Australia, New Zealand, and Sweden have entered the third stage of the downturn, and the decline turns to be much faster than in the 2000s.

The economists predict a 20% prices drop for Canada and New Zealand and smaller decreases for the U.S. and other markets.

But it’s important to understand that banks and households are in much better shape right now to withstand this change than back in 2008, he says.

“This crisis will hardly be as huge as the one in 2008. However, a housing decline will still hurt developers and the construction sector, and it may lead to problems in the non-bank financial sector. Downturns are able to show vulnerabilities where you couldn’t have expected them,” – he explained.

In Capital’s opinion, the “change from boom to bust in real estate” will reduce the GDP in the U.S., UK, Canada, Australia and New Zealand by 0.5-2% during the next few years. Canada, Australia and New Zealand are expected to face the hardest hits.

The downward trend will hardly stop the U.S. Federal Reserve or the Bank of England from raising rates in 2023.

“However, in Canada, New Zealand, and Sweden, where vulnerabilities are stronger, the rates may go up not as fast as the markets are predicting now,” – noted Shearing.