How do house prices look now

And what might happen next?

House price bubble

Let’s take a fresh look at UK house prices.

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For thoughts on USA house prices go to this page

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

Here I want to ask if UK home prices are ‘fair’ value 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

Homes in the UK (and a few other countries) appear to be very over priced.

At least that was the conclusion of this analysis from the Organisation for Economic Cooperation and Development (OECD) earlier this year

So, home prices are now ‘vulnerable’ to the risk of a price correction in the event that borrowing costs rise or income growth slows.

To be blunt – there is a real risk of a house price crash as Paul Cheshire (A professor at the London School of Economics) said on 2 July 2017.

“We are due a significant correction in house prices. I think we are beginning to see signs that correction may be starting,”

He told the Mail on Sunday that prices could fall as much as 40 per cent.

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“Historically, trends seem always to start in London and then move out across the rest of the country. In the capital, you are already seeing house prices rising less rapidly than in other parts of Britain.”

He said that a fall in real incomes is likely to spark a crash – and that’s the situation we’ve had for some time. See second chart below.

What’s more, his fellow LSE professor Christian Hilber has warned that,

“If Brexit leads to a recession and/or sluggish growth for extended periods, then an extended and severe downturn is more likely than a short-lived and mild one,” 

Okay but this risk has been present for a long time now

So what’s new?

Well, nothing’s really new. What’s happening is that basic free market economics are starting to reassert themselves after our extended period of ’emergency’ interest rates.

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 trouble is that the housing market has not been a properly functioning ‘free’ market for some time.

Interest rates have held down at 300 year lows for many years as this ‘shocking’ picture shows.

Just how far they fell in recent years – and how far below (what anyone would describe as) ‘normal’ they are now .

Bank rates since 1694

Obviously, super low interest rates makes mortgages easier to pay – which in turn makes homes more affordable.

And whilst that’s been good news for mortgage holders over recent years – it’s also seriously ‘distorted’ the price of houses.

I really don’t think that anyone is going to thank the Bank of England (BoE) – who control the price of money (a.k.a. interest rates) – if (or as many think – ‘when’) 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 now – as those experts above point out.

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What the experts say about interest rates

Some ‘experts’ are predicting that interest rates will stay 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.

So, 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 means a 100% increase in interest paymentsClick To Tweet

Get the latest on ‘interest rate’ thinking here.

Okay but are UK house prices really out of line with historical norms?

Well, take a look at these two charts and make up your own mind.

This chart tracks average house prices (in today’s money terms) against people’s average earnings (Over more than 50 years)

House prices historically connected
And this chart looks at first time buyer home prices relative to their earnings.

Mad price of FTB homes

The key thing to understand is that it’s this ratio (of prices relative to earnings) that tells you most about 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’ at the moment.

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’d already got there by 2005.

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.

Now that was just before the last crisis in 2008-09.

But notice how that ratio did not even fall back (in that crisis of 2008-09) to its peak level during the previous boom.

In short, UK house prices did NOT really 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 🙁

Here’s the data from ‘The Economist’ to prove it.

House prices. The Economist.

So are we due another crash?

Well, I don’t know, and nor does anyone else but, as those professor’s from the LSE are warning – it does look increasingly likely.

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 are caught – in a very 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.

What we do know is that new buyer enquiries are falling as we can see here  – and that’s not good for prices.

However, this chart also shows that fewer people are putting their homes up for sale – so that could hold the market up for a while longer.

buyer enquiries collapsing

House prices are sticky on the way down

because sellers don’t like to sell into a falling market.

So price crashes only tend to happen when they’re forced to.

Now, there is evidence of one group of owners who are ‘feeling the heat of property ownership’ and are looking to sell up.

The current and nasty dynamics in the buy to let sector now could most certainly trigger a crash.

So check out those issues here

I hope that this Insight has shown you some of the risks in house prices . . .

And, if you think it could be useful to your friends, please share using the social media buttons around the page.

They might thank you for it 🙂

Take care.


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