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Network News • 03-11-2022

What causes a property bubble to burst?

Author: George Mangion - Senior Partner PKF Malta
Published on Malta Business Weekly: 3rd November 2022

The war in Ukraine has made the propensity for inflation to rise faster. On the other hand, it has sparked sharp increases in energy prices and other commodities, pushing inflation above 8% in America and 10% in Europe.

Malta is feeling snug at 6.8%, yet this rate is not the real one, as government is directly capping price increases of imported energy and cereals.

At the present there are circa 8,500 unemployed, or 3.7%, as revealed in the latest Labour Force survey. At the same time, business and consumer confidence is slowly crumbling in economies which buy our exports. During the first half of this year, we witnessed a significant growth in inflation across most EU economies, resulting in increases in the price of various imported goods and services.

Malta was not immune to such inflationary pressures and saw consumer prices jump from an average annual rate of 0.7% last year to an annual rate of 6.8% in July. Can we define that is a harbinger of a property bubble, that may eventually collapse? Simply put, bubbles are caused by a variety of factors including rising economic prosperity, low-interest rates, banks offering competitive mortgage offerings and easy access to credit.

Forces that make a housing bubble to burst include a downturn in the economy, a rise in interest rates, higher unemployment and a drop in demand. Why is housing such an important factor when governments can easily monitor the supply of affordable listings to reduce poverty and increase economic mobility.

The 2023 Budget grants a €1,000 annually for 10 years to first-time buyers to shoulder increases in bank interest rates and a bevy of charges. Research shows that increasing access to affordable housing is the most cost-effective strategy of reducing poverty and increasing economic mobility. In Malta, the latest reports show that 16% of the entire population is caught in a poverty trap. So, are these the factors that can cause a housing crash?

The prime mover is a sharp decline in real estate values that typically follows a prolonged period of artificial high house listings. Housing crashes are generally caused by a slowing economy (Malta’s economy is expected to shrink by 6% to 8% next year and plans to borrow more than one billion euros to balance inflated expenditure.

Inflation will continue to increase following the ECB’s policy to control inflation by rising interest rates, causing a hike in mortgage lending rates – all of which can contribute to a decline in demand. Housing bubbles burst because the economic conditions that inflated the bubble are no longer in place. For example, when interest rates rise (as most predict this is a certain predicament), the cost of home ownership rises as well, placing a downward pressure on market prices.

Such a measure would further increase the developers’ costs and decrease buyers’ affordability, by increasing the monthly loan repayments and in turn decreasing the amount buyers could borrow. In Britain, two million households could see their mortgage absorb another 10% of their income, according to official estimates. Those who cannot afford the payments may have to reluctantly place their house on the market (this creates a downward pressure on listed prices).

For instance, studies show how in Britain mortgages make up almost 7% of lenders’ loan books, compared with 12% before the financial crisis. In Asia, we observe how things started to go wrong last year in China with the default of Evergrande, a giant realtor and developer. In parts of the country, distress is turning into defiance with mortgage-holders banding together and threatening to stop repaying their loans if work does not resume on long-overdue homes. Locally, one appreciates a KPMG scientific report based on a national conference they hosted on 4 October 2019. This conference occurred before the onset of the pandemic in March 2020, yet speakers warned that Malta is quickly building a reputation as a destination for working-class migrants and low-cost tourists as a result of local tendencies to accept compromised quality as a means of cutting costs.

The KPMG survey also comments that in 2019, the common opinion among industry operators was that local banks are famed that they have a role of brewing trouble due to their risk-averse attitude towards lending. Some mentioned excess bureaucracy and acute challenges experienced by non-EU residents when opening bank facilities.

In conclusion, the Malta Developers Association, the Chamber of Commerce and others have cautioned the authorities that a bubble may burst due to runaway inflation in building costs, future increases in mortgage rates, lack of enforcement of building standards by the Planning Authority and other regulators, coupled with a risk of a looming recession in Europe.

Author: George Mangion - Senior Partner PKF Malta
Published on Malta Business Weekly: 3rd November 2022
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