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The truth about house prices
James Andrews of MSN
November 02 2007
House prices are plummeting, the buy-to-let sector is ruined, repossessions are soaring and
first-time buyers will never get on the property ladder – ever.
That is the impression you get if you read the latest house price headlines in the press, or
watch the news. And I haven’t even begun to mention the recent Northern Rock run or the
credit crunch.
But really - what’s actually going on with house prices?
House prices are not falling
They’re just not. Of the seven major indexes combined to produce The Financial Times House Price index there have been six one-off falls in the last 12 months – out of 81 available
readings (three indexes have not filed for September yet).
No index is reporting year-on-year falls – or anything close to them (the smallest yearly
growth in September was 5%). And this is not a question of London’s soaring markets
making up for losses elsewhere. According to the FT index, the lowest annual growth for any
region in the country is 4.4%.
What is falling is the annual growth figure. But this is not the same as falling prices. In fact, a
falling growth figure is arguably good for the property market.
House prices consistently rising by more than 10%-a-year is unsustainable, it means
mortgages have to go up, indebtedness has to go up and new buyers are squeezed, as property
values rise faster than earnings.
And in many ways even people on the ladder are not that much better off. While your house
might be worth £20,000 more than it was a year ago, to access that £20,000 you need to
either re-mortgage (and get into more debt) or sell your home. Selling your home often leaves
you with nowhere to live and if the house you want to buy is now also worth £20,000 more
then you are no better off.
Stable not dropping
We have had something similar to this drop-off in growth before and not even very long ago.
In 2005, following a string of increases to interest rates by the Bank of England, house prices
stalled.
Nationwide and Halifax started reporting a small fall one month followed by a small rise the
next in late 2004 (six falls and six rises from Halifax between August 2004 and July 2005 and
five falls and six rises from Nationwide from December 2004 to November 2005). This saw
house price growth plummet from 15% a year to as low as 1.8% according to Nationwide and
a similar fall from Halifax.
During this period, repossessions rose and mortgage lending collapsed by more than a third.
But house prices didn’t.
All it took was one small cut in interest rates by the Bank of England in August 2005, and
house prices resumed their upward trend.
What is behind the recent house price rise?
There are several reasons house prices have been soaring recently, but one of the most
important is that the British population likes houses.
Houses are tied up in the national consciousness, from the saying “an Englishman’s home is
his castle” - which also applies in Northern Ireland, Scotland and Wales - to the sheer number
of property shows on television every week (more than 70, different, regular series on
terrestrial channels alone in 2006).
This means the desire to own, improve, move and buy houses is higher than it is in almost
any other country and this has seen the market defy expectations in recent years.
On top of this there are some more fundamental economic factors – the UK’s population is
growing and the number of people in each property is falling. That means we need more
properties.
Unfortunately we are simply not building enough new homes - simple supply and demand
factors mean house prices will rise in this situation. And if figures predicting a massive
increase in UK population over the next few years are to be believed, this demand will only
increase.
Another factor is buy-to-let. In 1996 the first buy-to-let mortgages were introduced to the
UK. The idea was to allow people to become landlords more easily. It worked – and was
incredibly popular.
The rise of buy-to-let has also allowed people to use up some of the increase in their own
home’s value to buy new ones (and covering the new mortgage with rental income). This has
driven demand at the lower end of the market where first-time buyers are becoming
increasingly priced out.
Since the introduction of buy-to-let at the end of the last proper house price crash (1989 to
1996) there has not been one occasion when house prices have fallen two months in a row
according to the FT house price index of indexes. According to the Council of Mortgage
lenders (CML), the number of buy-to-let mortgages increased 14-fold between 1998 and
2006.
The number of people employed has also increased, unemployment rates during the last crash
hovered around 10%. They have been no higher than 5.5% since April 2000, while the
employment rate is around five percentage points higher than during the last crash, according
to Office for National Statistics data.
Having a lot of employed people and few people losing their jobs means more people looking
to buy and fewer people forced to sell.
Relatively low interest rates have also been a factor. House prices may have risen but that
does not necessarily mean homes are less affordable. In 1989 as house prices started their last
major slide interest rates rose as high as 14.875%. For the last few years interest rates have
been far lower – dropping to 3.5% in 2003.
Even after the Bank of England’s decision to increase rates three times this year to a six-year
high, the underlying cost of borrowing is still only 5.75%. This means people can borrow
more than twice as much as they could in 1989 at the same cost. Couple this with increased
earnings over the period and a large part of the rise in house prices can be explained.
Competition between mortgage lenders has also meant there is a smaller gap between
underlying financial markets and the rates Britons pay for their mortgages now. In some
cases banks and building societies have offered fixed-rate deals at less than the current bank
of England base rate.
Expectations are also behind a large degree of house price rises. After a decade of increases
Britons simply think house prices will keep going up, seemingly forgetting the crash in the
late 80s and early 90s. But as long as people think prices will keep rising, they will keep
buying and property values will increase.
One study calculated once the economic factors had been stripped out, one third of recent
house price growth was based on optimism by buyers.
What is behind the slowdown?
The slowdown has been driven by increased mortgage costs as first the Bank of England
raised rates (as in 2004/2005) and then the international credit crunch pushed the cost of
borrowing higher.
Increased mortgage costs have led to an increase in repossessions, putting more homes onto
the market. However, repossession this year are only predicted to be worth 0.25% of all
mortgages and even if this jumps by a half next year - as the CML predicts - it will result in
just 45,000 repossessions (0.38% of all mortgages), well below the figures during the last
crash.
As well as stretched affordability and increased repossessions, there has been negative news
in the press. As the number of stories screaming about the crisis increases, people are less
sure they want to move home. This has meant house prices are rising more slowly.
These last two factors have combined to make buy-to-let (which has supported the market for
so long) less viable as costs of mortgages have increased and landlords are not benefiting
from fast increases to the price of their rental properties.
Where next?
Many of the factors behind the recent rise in house prices are still there.
Employment is still high, unemployment still low, interest rates still relatively low (at least
compared with the last crash) and UK residents still love their homes.
On top of that houses are still not being built fast enough to keep up with increasing demand.
With employment, demand and desire for homes as high as ever it would be very surprising if
house prices fell or even stopped rising entirely.
This is because at the first sign of a drop, a large number of the people employed and waiting
to buy would flood back to the market.
Even without a fall, a small drop in the cost of borrowing would see people return in large
numbers and ease the pressure on those struggling with higher rates (you do not get your
home repossessed overnight, it takes months of missed payments).
In 2005, when the house prices last stalled, it took just one cut of interest rates to kick-start
the market again, and the CML is not alone in predicting interest rates will fall more than
once in 2008.
The question is whether the belief that houses are a good investment - that has driven so
much of the recent growth - will continue.
Currently, the media are giving the notion of ever-increasing house prices a kicking, but dig a
little deeper and you will see that when you ask people where houses will be in 10 years they
almost all believe the prices will have risen.
For these reasons, the current “house price crisis” looks little more than a wobble.
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