House prices now

By | On January 4 2017
House price bubble

Let’s take a fresh look at house prices.

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For a short note on USA house prices go to this page.

Or to see if RENTING really is ‘money down the drain’  see here

Here I look at whether UK houses are ‘fair’ value (in general terms) right now – and what might change that situation.

I’ll focus on the national picture, because that’s what will lead the trend in most locations.

But please remember that a ‘good price’ for a home can vary (a lot) between properties in one location and between cities and regions too. So, we’ll look at regional extremes in another Insight.

The picture in a nutshell

According to this analysis from the Organisation for Economic Cooperation and Development (OECD)

House prices in the UK (and a few other countries) appear to be overvalued and still rising. 

This makes prices ‘vulnerable’ to the risk of price correction if borrowing costs were to rise or income growth were to slow.

In short – there is a real risk of a price crash – but then there has been for some time now.

So what’s going on?

The old ‘free market’ idea

I guess we all know that it’s demand and supply that drives the prices of most things in free markets. And houses are no different.

The question is whether the housing market really is ‘free’ at this point in time – and I don’t think it is.

Just think about interest rates – which have been held down at 300 year lows for many years now.

This ‘shocking’ picture shows just how far they’ve fallen in recent years.

It also shows just how far below (what anyone would describe as) ‘normal’ they are now .

Bank rates since 1694

Super low interest rates makes mortgages easier to pay.

And that, in turn, makes homes more affordable.

Now, that may be good news for mortgage holders, at the moment, but it’s seriously ‘distorting’ the price of houses. And no one will thank the Bank of England (BoE) – who control the price of money (a.k.a. interest rates) – if house prices come sharply back down as a result.

The truth is that we just don’t know what will happen to house prices as the cost of borrowing (and the supply of houses for sale) start rising. But clearly there are some big risks in this market as the OECD have pointed out.

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What the experts say about interest rates!

Some ‘experts’ are predicting that interest rates will stay this low for many years to come.

That’s an interesting view, but let’s remember that very few experts predicted interest rates would stay this low for so many years back in 2009. Most of them expected that the ’emergency’ measure of super low interest rates would be just that, an emergency short term measure. They thought that we’d have returned to more ‘normal’ interest rates long before now.

They were wrong back in 2009 and they might be wrong now. It’s always safest to take predictions (from any ‘expert’) about interest rates (or asset prices generally) with a pinch of salt 😉

We just need to be aware of, and manage our risks.

One potential shock to our financial system could come from the falling pound. And this is because the BoE may decide to intervene, to prevent a currency collapse.

They don’t like the risks to inflation caused by the pound falling against other currencies. And the costs of our imports – which make up a large proportion of what we buy – goes up as our currency falls.

So, they could intervene – by raising interest rates – as they’ve done in the past, when the pound has collapsed.

If you look at history – short sharp rises in interest rates were quite common:

  • Interest rates rose by 12% in around two years in the late 1970s
  • They rose by 5% in less than one year in the mid 1980s
  • And they rose by nearly 7% in just over one year in the late 1980s.

So don’t believe anyone who says they’re sure that rates will stay down for a long time.

And, to be clear, I’m not suggesting that such massive increases in interest rates are on the cards today. I’m simply pointing out that even a very small increase from today’s very low rates would create a lot of pain for borrowers.

A 2% increase to a 2% mortgage rate is a 100% increase in interest payments . . .

But I digress 😉 . . . so we’ll have to come back to interest rates and other factors driving demand and supply for housing another time.

For now, let’s see where UK home prices ‘sit’ relative to their historical norms with these two charts.

This first chart tracks the average UK house price against people’s average earnings (Over more than 50 years)

UK house prices and Earnings
And this chart looks at first time buyer home prices relative to their earnings.

First time buyer HPER chart

It’s this ratio (of prices relative to earnings) that gives a good clue to value. 

With homes, we can look at prices relative to earnings of the prospective buyers (as in the chart above) – or we can look at the rental ‘earnings yield’ of the properties.

And both of these numbers give clues to value in times of normal interest rates.

The trouble is that times are ‘not normal’ now.

So, what do these charts tell us?

Well, I think they tell us that UK house prices are now in outer space!  And that they got there by around 2003.

This initial ‘take off’ came off the back of interest rates being drastically reduced to fend off the effects of the bust in the stock market.

Having seen a bubble in technology stocks, our central banks then helped to create another one in property.

And, as you can see, since around 2003, UK house prices have become completely detached from people’s earnings.

The charts also prove that this ‘disconnect’ can persist for a very long time when it’s supported by super low interest rates.

But of course, at some point, some kind of connection has to be re-established because because it’s only peoples’ earnings that can support house prices over the long run.

Tell me more . . .

Okay, well these charts present two worrying signs.

First, notice how the first time buyer ratio is now back to its 2007 peak (Just before the last crisis in 2008-09)

And second, notice how that ratio did not even fall back (in that crisis) to its peak level of the previous boom.

In short, UK house prices did NOT crash in the financial crisis of 2008-09. They did in the USA and other countries with house price bubbles. But not in the UK at that time. 

The previous boom, by the way, topped out in 1989 and ended, as they all tend to, in a crash.

I was there for that one – and it really wasn’t much fun 🙁

So are we due another crash?

I don’t know, and nor does anyone else.

We could potentially escape one if people’s earnings grew fast enough – to bring that ‘ratio’ back into a more normal range.  Although there doesn’t seem to be much upward momentum in people’s earnings at the moment . . .

And while this could change (relatively quickly if inflation spiked upwards due to our falling pound) the Bank of England would then be under pressure to push inflation back down again with higher interest rates.

So, I think we’re in a tricky place right now.

We’ve painted ourselves into a corner of high asset prices with these ultra-low interest rates.

And while that might feel just fine for those holding assets (houses or stocks) it’s not feeling very good for the majority.

The key question is this . . .

Can house prices be held steady (or brought gently back to earth) as people’s earnings grow to support them?

This is puzzling a lot of the world’s ‘expert’ economists right now, but sadly, as ever, they can’t agree on an answer.

So we’re left to work out the risks for ourselves.

I hope, at least, that this Insight has shown you some of those risks.

And, if it might be useful to your friends, please share. They might thank you for it 🙂

Have a great day.


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