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SALEM, Ore. (CNN/Money) – Americans aren't the only ones who've gotten rich off real estate. In fact, home price gains in the United Kingdom dwarf those of the United States.
Between the fourth quarter of 2000 and 2004, U.K. home prices increased 88 percent, on average, according to the Halifax house price index. U.S. home prices, meanwhile, increased 35 percent during that time, according to the National Association of Realtors.
The U.K. housing market started to gain steam in the late 1990s, beginning with the higher-priced properties in London and spilling over to virtually every region and every type of housing. "Buy-to-let" became all the rage as investors shifted funds from their traditional portfolios into rental properties.
"Every week there were stories in the paper about people making more on their property than going into the office," said Ed Stansfield, property economist at Capital Economics in London.
Then, with little warning, the market cooled.
"It was rising at a 20 percent annual rate and then suddenly stopped in its tracks," said John Calverley, chief economist and strategist of American Express Bank in London and author of "Bubbles and How to Survive Them."
While economists disagree on whether the U.K. is experiencing a temporary lull or the beginning of a housing bust, buyers there seem to be waking up to the idea that double-digit price gains can't last forever. Prices overall have been flat, with small increases in some areas and declines in others.
Speculators seem to be having second thoughts. Sellers are wondering where all the buyers went. Retailers say that "house rich" shoppers are sitting on their wallets.
"My sense is that the U.K. market is two or three years ahead of the U.S. market," said Calverley. Every market has its own dynamic, but there are lessons to be learned from what's playing out across the pond.
Lesson: Rising rates do take a toll
During the U.K. housing heyday, most experts agreed that higher interest rates would probably dampen buyer enthusiasm. As in the United States, many argued that the effects wouldn't be drastic because higher rates usually go hand-in-hand with an improving economy.
Yet, U.K. buyers -- who typically finance with monthly adjustable-rate loans -- did eventually take notice after the Bank of England started raising rates. By most measures, housing prices started declining in June 2004 after the bank's third quarter-point rate increase.
The Federal Reserve's eight quarter-point rate increases have done little to scare away U.S. buyers, who unlike their U.K. counterparts have the option of getting a fixed-rate mortgage. In the priciest markets, however, many buyers are resorting to interest-only loans in order to afford the monthly payment. These buyers are most vulnerable to the double-whammy of rising rates and declining home prices.
"In the U.S., the markets that are most risky are those where there is a higher proportion of buyers using adjustable loans and interest-only loans," said Thomas Skinner, managing partner of Redbrick Partners, a U.S. investment management firm that invests in single-family housing and is modeled after similar U.K. firms.
Lesson: Speculators are a fickle bunch
Investors who bought property with the idea of flipping it for a quick profit or renting it out played a key role in driving up U.K. housing prices.
Now they appear to be on an extended holiday.
According to the Council of Mortgage Lenders, lending to "buy-to-let" investors dropped 18 percent between the first and second half of 2004 – compared with only a 3 percent drop for owner-occupied buyers. During that time, the number of such investors unable to meet their mortgage payments increased 50 percent.
"People were buying thinking they'd rent it out and make 15 or 20 percent appreciation, but now they're left with only the rental yield," said Stansfield at Capital Economics.
Investors haven't rushed out to sell property, he said, but demand for the type of property favored by investors is quite weak. If prices remain flat or decline, "you'll probably see a round of investors who decide they're overexposed and need to unload some of their property."
Lesson: Supply isn't so limited after all
A year ago, everyone believed the supply of houses for sale simply could not keep up with demand. It was a sellers' market.
"There was a view that prices would keep going up forever," said American Express' Calverley.
Today, it appears buyers have the upper hand. According to the Royal Institution of Chartered Surveyors, the supply of houses for sale in March is fully a third greater than it was a year ago.
"In these markets there is a herd instinct where people rush out to buy but then as soon as people think differently suddenly there are no buyers," said Calverley.
There is a backlog of property for sale, more is coming up for sale and so sellers – who usually prefer to keep houses on the market rather than lower their asking price – are starting to rethink that strategy.
The impact of psychology on the housing market is slower than in the stock market, Redbrick's Skinner added. But if people are buying with the expectation of prices going up 15 percent, he said, demand will drop off the moment the expectation changes.
Lesson: When the going gets tough, some foreclose
When the U.K. market was hot, said Stansfield, lenders became increasingly lenient in their credit standards, allowing for higher debt-to-income ratios, smaller down payments and more creative financing.
"The mortgage industry took great pleasure in the fact that the number of people in arrears was very low and possessions (foreclosures) were at an all-time low," he said.
But as rates rise and double-digit price gains disappear, borrowers are starting to feel the squeeze. As of February, the number of mortgage repossession actions in the courts was at the highest level in five years, and many expect it to rise further.
"What we're seeing now is the first signs of stress," said Stansfield.
Lesson: Housing woes affect the rest of the economy
The U.K. housing market hasn't gone bust. But homeowners can no longer rely on double-digit price gains to prop up their standard of living -- and that reality is trickling through to the rest of the economy.
According to an article in the Financial Times, High Street retailers are finding a "sober mood" among consumers, while demand for big-ticket items, such as cars, has dropped off sharply. Households have suffered from a "money illusion," said one economist quoted in the article, and are only now realizing that they actually aren't richer.
"You have a lot of people here [in the United States] consuming housing wealth," said Skinner explaining that some homeowners are either spending their home equity or saving less because they assume their rising property values will fund their retirement for them. "Even just a slowdown in appreciation would probably impact spending," said Skinner.
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