Impacts of crisis on UK real estate sector

Impacts of Crisis on the UK Real Estate Sector Student's Name Institutional Affiliation Course # and Name Professor's Name Submission Date Impacts of Crisis on the UK Real Estate Sector Introduction The concept of "crisis" has played an essential role in contemporary academic and policy imagination (Roitman, 2013). Over the past few years, the world economy has encountered multiple crises due to unpredictable settings, such as the global financial crisis in 2008 and the COVID-19 epidemic in 2019. From an economic perspective, the 2008 global economic crisis and the COVID-19 crisis significantly negatively impacted the UK economy, including high unemployment and low activity in most major industries, particularly the property sector (Matte, 2018). However, the crisis affected the property sector differently. Such differences can be attributed to government policies and measures implemented. My research goal is to study the government's policies, more specifically, monetary policy, on the real estate sector during the two crises and analyse the relationship between housing prices and interest rates. Interest rate policy is a crucial component of monetary policy, exerting a substantial influence on real estate prices. When the interest rate increases, the cost of loans and house purchases also increases. This leads to a decrease in the demand for housing, which in turn impacts the supply and demand dynamics of the real estate market and the trajectory of housing prices. However, mortgages might be linked to long-term rather than short-term interest rates, and the relationship might differ significantly (Cooper, 2004). Therefore, one focus of this paper is to consider both the relationship between short-term interest rates and the housing market and the relationship between long-term interest rates and the housing market. The central bank's interest rate setting also shapes the housing market dynamics (Martin et al., 2022). Therefore, another focus is to analyse the time-varying relationship during each crisis. The research results show that the effects of government policies and the dynamic relationship between housing prices and interest rates are seriously affected by market dynamics and consumer confidence. In the early and severe stages of the crisis, the impact of UK government policies was weak. Even with low-interest rates, a lack of consumer confidence still pushed housing prices downward, which resulted in an abnormally positive relationship between interest rates and housing prices. In the later stages of the crisis and the average period, interest rates and house prices are generally inversely related. Lower interest rates can reduce borrowing costs, thus stimulating demand for home purchases. This paper will be divided into three main parts. The first chapter will review government policies during the 2008 financial crisis and the relationship between interest rates and house prices. The second chapter reviews government policies and the relationship between interest rates and housing prices during the COVID-19 pandemic. The third chapter compares the similarities and differences of the previous two chapters. Finally, the concluding remarks will summarise my findings. Part 1: Analysis of the 2007 Global Financial Crisis While financial crises may initially originate in one country or sector of the financial industry, their effects can quickly extend to other regions or even have a worldwide influence. The financial crisis of 2008 began in 2007, after a period of historically low-interest rates that contributed to a property bubble in the UK. The Federal Reserve is considering a significant decrease in the Federal rate funds, from 6.5 per cent to 1.25 per cent, in light of the bubble's collapse, a string of corporate accounting scandals, and the 9/11 attacks (Wigmore, 2021). The consequence was an unprecedented invasion of the economy with inexpensive currency. Consequently, there was a substantial increase in house prices as borrowers capitalised on the favourable mortgage rates. World economists are primarily concerned with the repercussions of the financial crisis in the United States and its spread to important financial nations such as the United Kingdom. The participation of the Bretton Woods institutions during the economic catastrophe, along with the individual efforts of the affected countries, helped to control and reduce its impact effectively (Fioretos & Heldt, 2019). Subsequently, several valuable insights could guide the financial rescue package aimed at reigniting economic growth in the U.K. after the interruptions caused by the Coronavirus epidemic in the wake of the global financial crisis. The 2008 GFC has demonstrated that the housing market is embedded in international financial flows (Kennett et al., 2013). It is unsurprising to see this because the lending and borrowing regime has developed since the deregulation of the 1980s and the growth of securitisation in the 1990s (Scanlon et al., 2008). The regime makes lending and borrowing more reckless. However, it also implies that the crisis in the financial markets will spread quickly to the housing market. From early 2008, the regime set off at an alarming rate (Kennett et al., 2013). Through analysing government policy, interest rates are vital since they can be a benchmark for the mortgage lending rate. Therefore, the following subsection will discuss the government interventions, followed by the literature review about interest rates and the housing market during the GFC. Government Intervention From 2009 to 2019, the UK government implemented numerous reforms to its regulations and policies to enhance governance and foster national development. Consequently, within those alterations of policies and regulations, several rules and policies had a significant impact on the housing sector of the UK in diverse manners. These measures aimed to stabilise financial markets, safeguard the housing market, and foster economic recovery. An increase in the interest rates for bank loans or mortgages is one of the modifications implemented by the United Kingdom government from 2009 to 2019 (Miles & Monro, 2021). In addition, the government of the UK's decision has had a detrimental impact on the UK housing sector. Furthermore, a significant number of clients in this specific industry are inclined to make a purchase only if the banks grant them loans or mortgages. Moreover, as a result of the government's pressure, the banks raised the interest rate, which subsequently led to a higher likelihood of a decline in sales within this specific sector. Consequently, the housing sector in the UK was unable to effectively handle the decline in sales, resulting in significant financial losses for the sector. Furthermore, in April 2008, the government declared assistance for first-time homebuyers as a means to bolster the housing market and enhance buyer assurance immediately. The UK government implemented a strategic plan facilitating the development and expansion of the UK housing sector. Furthermore, the government decided to offer assistance to UK citizens who were purchasing their first home (Enria et al., 2021). The government introduced the First-Time Homebuyer Tax Credit policy in 2010. In addition, the government has offered loans to first-time homebuyers as part of their support initiatives. The lending ceiling was set at $8,000, and the main appeal was the specified timeframe during which citizens may repay the loan to the government. The loan had a repayment period of 15 years. Consequently, following the specific assistance offered by the UK government, there was an unforeseen rise in the interest of residents purchasing their first home. During this specific period, the housing sector in the UK experienced a significant surge in sales, with over 850,000 houses being sold. The suspension of land tax and stamp duty on properties under £175,000 was also imposed (Lund, 2019). This initiative has alleviated the economic strain on prospective home purchasers and boosted engagement in the real estate industry. Within the conventional economic policy framework, the Bank of England and other central banks influence the economy by influencing the policy interest rate. This involves controlling short-term and long-term interest rates and impacting asset prices, exchange rates, consumer spending, investment, and inflation. With the deepening of the crisis, especially in October 2008, the British government took more direct and decisive measures in the face of the severe banking crisis. The government unveiled an extensive bank recapitalisation strategy, investing funds into several prominent banks to prevent their failure and uphold the general reliability of the financial sector. As part of the proposal, certain institutions, such as the Royal Bank of Scotland and Lloyds Banking Group, will partially nationalise. In order to boost economic activity and alleviate the increase in long-term interest rates, the Bank of England adopted a quantitative easing policy in January 2009 (Youds, 2019). Quantitative easing is a monetary policy tool that involves the purchase of government bonds and other securities. Its objective is to boost the money supply in the economy and reduce long-term interest rates to encourage economic activity. In theory (Matteo, 2018), the policy should help make credit markets more liquid, encouraging businesses and consumers to borrow and spend. However, despite these interventions, prices and transactions in the UK property market fell in 2009 as credit markets tightened. During this period, uncertainty in the housing market and low consumer confidence weighed on the market. In 2010, as the government introduced more measures and the housing market gradually stabilised, the UK economy began to recover slowly (Lenoël & Young, 2020). The government has implemented programs, including Help to Buy, to support first-time buyers and low-income families and stimulate housing demand. These policies will help restore market confidence and promote the active real estate market. Since 2014, thanks to continued policy support and an improving economic environment, the UK property market has rebounded, showing signs of growth. Literature Review Interest rate fluctuations and their effect on housing prices in the UK have been extensively studied through empirical research. However, most of these studies have focused on the impact of interest rates on housing prices without considering any changes over time. Some studies, on the other hand, have conducted conditional analysis. Several theoretical frameworks of the term structure that underlies interest rates have been developed over the last 20 years. There are numerous advantages to comprehending the term structure of interest rates better. Recently, several research have focused on the empirical examination of interest rate determination (Tse et al., 2014; Aha et al., 2022). Interest rate volatility generally affects every facet of the economy, even though the exact direction of the relationship between interest rates and profitability is difficult to establish. The rapidly increasing interest rates have impacted the United Kingdom's housing expenses. Nonetheless, prior research has examined three interest rate types: short-term, absolute mortgage, and long-term rates, demonstrating the relationship between interest rate type and real estate. This review observed substantial variations in the correlation between housing prices and interest rates over time (Tse, 2014). We used Figure 1 to present them, which comes from Tse's article. In this figure, the x-axis is Time, and the y-axis is the relative housing price to the year 2000 housing price, which means that if it is in the year 2000, the y value is (2000 housing price/2000 housing price)*100=100. As shown in Figure 1, in the pre-crisis period from 2000 to 2007, when interest rates fell, the relative house prices rose (implying a negative correlation) because the UK experienced a housing market boom characterised by loose lending standards and low-interest rates. However, Read (2022) asserts that with the outbreak of the crisis in 2007, the Bank of England gradually lowered the base interest rate from 6% in 2000 to 5.75% in 2007 and reached 2% at the end of 2008. Although the central bank's lower interest rates are aimed at stimulating housing demand, the recession has hit consumer confidence hard, and banks have tightened lending standards with tightening credit. As a result, customer demand for home purchases has decreased significantly. According to data from the UK National Building Society, although interest rates are falling, the average UK house price fell by about 16.1 per cent between 2007 and 2009 (Kara et al., 2020). During this period, interest rates showed an abnormal positive correlation with house prices (Tse, 2014). Until 2009, the central bank lowered interest rates to a historical low of 0.5% and implemented quantitative easing, which eventually gradually promoted the stability and recovery of the real estate market (Fischer, 2021). In 2010, house prices began to rebound, surpassing pre-crisis levels by 2013. The delicate relationship between house prices and interest rates during the 2007 financial crisis indicates the complexity of market dynamics. Due to the severity of the crisis, the impact of rate cuts was initially weak. Therefore, promoting the real estate market's recovery after the economic recession becomes crucial. The UK belongs to a group of nations where a rise in home price inflation of about 2.6 percentage points would result from a one percentage point drop in short-term interest rates. According to Tse et al. (2014), there is plenty of proof that bank lending significantly affects the monetary transmission mechanism. Aha et al. (2022) explored the dynamic association between housing finance and property prices in the United Kingdom and how these variables interacted with macroeconomic difficulties. According to Aha et al., macroeconomic variables that affect employment and income levels and demographic patterns, including urbanisation rates and several new households, influence housing demand. In the UK, property purchasing as well as mortgage funding are connected. For a great deal of people and families, purchasing affordable real estate is costly and requires significant monetary investment over a long period. As a result, individuals seeking to purchase homes are forced to obtain long-term finance that allows them to acquire their ideal residences while spreading repayment based on the housing asset longevity. The mortgage as well as real estate markets are inextricably linked and have constantly evolved. During the 1980s, the UK government implemented deregulation measures for increased competition in the housing finance market, specifically in the mortgage sector. This resulted in a decrease in mortgage expenses and an increase in the availability of loans, providing the UK with a means to support the increasing desire to own homes. Due to decreased interest rates worldwide, the wholesale money markets expanded, particularly the securitisation market in the 1990s. Additionally, several large building societies transformed into mortgage banks after demutualisation. As a result, the UK experienced a substantial increase in competition and product innovation in the mortgage market. The 2009 program broadened this approach to allow low-credit and self-employed households to become homeowners. Allowing landlords to use debt financing to buy investment properties against anticipated rental income boosts owner-occupation and rental housing development. Government control over monetary policy affects demand. Government reserve requirements and short-term interest rates affect loanable funds and borrowing costs. This affects housing demand and affordability. The BoE began Quantitative Easing in March 2009. This policy increased the central bank's balance sheet and money supply by buying liquid assets. The global financial crisis of 2008 had a long-term impact, particularly on the property market. Prices have increased due to continuously low loan rates, which is an essential strategy to support economic recovery. There has been a rise in demand for real estate, particularly in areas where it is scarce. As prices keep increasing sharply, first-time homebuyers and low-income families find it more challenging to fulfil their dream of becoming homeowners. The high cost of homes has terrified many prospective buyers, as they have not only returned to pre-crisis levels since 2010 but have also routinely surpassed income growth since 2013. The transition from viewing housing as a means to establish a residence to regarding it as a monetary investment has resulted in a rise in the cost of owning a home, making it more and more difficult for people to afford. Studies on the correlation between homeownership and wealth accumulation indicate that multiple variables influence the financial viability of homeownership for a specific household. According to Fuller et al. (2019), the rate of property price appreciation, the type of mortgage received, tenure of ownership, and the overall market circumstances of the period are essential factors that determine outcomes for low- to moderate-income households. The escalating housing costs h...