A Lecturer in Finance with specialist areas for teaching and research in financial risk management and financial markets, Martin Upton says:
“Like the weather and David Beckham, the subject of house prices is never far from the lips of the public. And the worry now is about what some see as the storm clouds over house prices and fears of a repeat of their collapse in the early 1990s.
“After a scorching rise in prices during the last three years, with house price inflation reaching 26% in March 2003, recent months have seen a slowdown in the market and a reduction in the annual rate to 15% in November 2004 (1). Both the Nationwide and the Halifax indices have recorded falls in average house prices in recent months with reductions since July of 0.6% and 0.9% respectively (1 & 2). Evidence from the property company Rightmove, showing house prices down 3% from their peak in July, paints a similar picture.
“These findings have been supported by the latest Royal Institute of Chartered Surveyors (RICS) survey report which showed that 41% more of the surveyors sampled reported price declines than rises in October (3). Accompanying this has been a fall in sales of mortgages – in October these totalled 83,000, down 37% from October 2003 (4). Mortgage approvals are now at their lowest since January 2000. Since approvals are a core driver of house price levels this has added weight to the view that house prices will slump in 2005.
“Adding to the gloom is the fall in property sales, with the RICS survey showing these down by 25% from a year ago (3). A further worrying development has been the increase in the number of repossessions – these rose in England and Wales from 16,098 in the third quarter of 2003 to 18,513 for the same period this year.(5)
“Certainly the ratio of house prices to earnings has risen sharply from 3.9 three years ago to 5.9 currently (the average for the past two decades is 3.8) (1) – again suggestive of the risk of a reversal in house price levels. This sharp rise in the ratio is making it increasingly difficult for first-time buyers to get a foot on the housing ladder – a factor that undoubtedly has helped take the heat out of the market. Elsewhere, demand for buy-to-let properties seems to be moderating in response to the low prospective rental yields.
“The recent trends in house prices have been, at least in part, a reaction to the higher cost of borrowing. The Bank of England’s Monetary Policy Committee (MPC) has raised official rates five times in 2004, taking base rates from 3.5% to 4.75%. The indication is that by having larger mortgages families are more sensitive than in the past to relatively small changes in interest rates. The impact of higher rates is, however, more than simply the cost of mortgages. The rate hikes have dampened confidence about the prospects for the housing market. The consequence is that potential buyers step back from the market and thereby the prophecy of softer house prices becomes self-fulfilling!
“With GDP growth moderating from 0.9% in the second quarter to 0.4% in the third quarter of 2004 the economic climate would also appear discouraging for the housing market. So is the outlook for the housing market for 2005 all storm clouds? The truth is that the gloom and doom is overdone:
- Periods of weakness in house prices are strongly correlated to weakness in the economy as a whole and particularly to high unemployment. At 4.6%, unemployment in the UK remains low – half the level it was between 1990 and 1992, which was the last (and indeed only) period of significant house price deflation in recent history.
- Real incomes in the UK are continuing to rise despite a slowdown in economic activity in the last quarter, supporting the capacity of families to meet mortgage payments.
- Despite the hikes in UK interest rates, mortgages remain affordable. Although the recent increases in interest rates have raised average mortgage payments for new borrowers from 14% to 19% of earnings, the current level is still substantially below the peak of 34% seen in 1990(2). Mortgage arrears – always a good indicator of the potential for distressed selling of properties – remain low.
- A third of mortgage lending in the past five years has been in fixed or capped rate products where, for the term of the product at least, home owners are immunized from the consequences of higher rates (6).
- The recent evidence of a slowdown not only in house price inflation but in the economy overall suggests that interest rates may have peaked. At 1.2%, Consumer Price Inflation is comfortably below the MPC’s target of 2%. While the MPC does have to be forward looking when considering its policy on interest rates, on the basis of current inflation (and the growing strength of the Pound against the US Dollar) further increases in rates seem hard to warrant. Indeed, the Bank of England’s Quarterly Inflation Report, published in November, observed that with economic growth slowing, upward pressure on inflation is easing. This view has been taken on board by the financial markets, where the growing consensus is that base rates have peaked at 4.75%.
- There seems no let-up in the appetite of the mortgage lenders to offer very competitively priced products often at rates which make you sit up and check just where base rates currently are! This competition for customers helps mortgagors fuel demand for property or, at least, afford the current level of their commitments.
- The rate of house construction in the UK currently falls short of the demand for housing arising from demographic change – including that resulting from the growth in the divorce rate and the related break up of households. Recent initiatives to increase housing supply, including the plans for new developments in Essex, Cambridgeshire and Northamptonshire, are years away from having even a scintilla of an impact on this shortage.
"An end to rampant house price inflation is not a precursor to a collapse in house prices, because this would fly in the face of current economic realities. 2005 will see falls in prices in some months and rises in others – with the latter concentrated in the second half of the year. Over the year as a whole, prices will remain largely unchanged.
"My forecast for the housing market in 2005 is of ‘bright intervals and scattered showers’ – rather than of storm clouds! "
