Myths about house prices

  There are problems with houses as a store of value in that they are an illiquid asset (you cannot convert them into cash easily) and, other things being equal, merely buying and selling them is what economists would call a ‘zero sum game’ – and not even this if costs and taxes are taken into account. This is, of course, unless you can (profitably) add value to them in other ways, are wealthy enough to own more than the one you live in and can sell at a real profit to the original price paid, or you sell up and move somewhere prices are cheaper on a like-for-like basis.

Spurred on by the popular press and relentless so-called ‘property porn’ programmes on television, myths about houses and UK house prices abound, the following probably being the most prevalent, and illustrative of the present speculative bubble:

House prices never go down

Buy-to-let is a sure-fire winner

Renting is ‘dead money’.

The idea that house prices never go down is as bizarre as the notion that stock markets never fall. And it is just as incorrect, redolent of the kind of short-sighted mania that occurs during any bubble, from the ‘tulip-mania’ affecting Dutch tulip bulbs of the 17^th century to the recent ‘dot com’ crash. The United States – which has had far higher levels of home ownership than Britain over the last 150 years or so – has seen several house price crashes, including after the bubbles of the 1830s, 1880s, 1920s and 1970s. A Florida mansion, for instance, bought in 1925 during the bubble of the ‘roaring twenties’ would not have reached its initial buying price again until forty years later.

Since the increase in home ownership in the UK over recent decades, a similar pattern has emerged. Just as with the stock market, the overall price trend may be upwards, but with some very noticeable periods of decline. The picture is sometimes partially obscured by the effects of general inflation, but once this is stripped away, it is clear.

For instance, the property boom of the early 1970s led to an 18.1 percent fall in house prices in real terms (i.e. taking inflation in account) between 1975-77. When the recession of the early 1980s hit, real house prices fell again. As unemployment took off to the highest levels since the Second World War, between 1979-82 house prices fell 17 percent (accounting for inflation). Then, as house ownership spread among the working class under the Thatcher government and levels of indebtedness soared to pay for it, the biggest crash was the most recent one in the 1990s, plunging millions of people into ‘negative equity’, where their houses were worth less than their outstanding mortgages, ending with hundreds of thousands of homes being re-possessed by the banks.

On this occasion, house prices fell 37.3 percent in real terms from their peak during the ‘Lawson boom’ in 1989 and didn’t recover fully on this measure until the beginning of 2002 (using the nominal ‘headline’ figures, the average UK house price in 1989 peaked at ú62,782 and eventually rose above this level again in early 1998, but this doesn’t take inflation into account as ú62,782 was worth considerably less in 1998 than it was in 1989). The bottom of this crash was in late 1993, and after that the housing market first started to recover, and then soared, to the extent that the average UK house is now around ú180,000, an increase in real terms of over 150 percent since the 1993 low (all figures supplied by, or calculated from, the Nationwide Building Society quarterly surveys). This is over three times the rate at which the UK economy as a whole grew during the same period.

 As a housing bubble, it is unparalleled in the history of the UK economy. Apart from the usual cyclical upswing and the relative boom in the UK economy over the last decade, it has been fuelled by two other factors. The first is the particular, continued expansion of the financial services sector centred in London and the South-East, which has had a ‘ripple effect’ on house prices across the country. The second has been the ‘buy-to-let’ bonanza, whereby people, realising that owning just the one house isn’t the best way of taking advantage of a rising market, borrow speculatively to buy two or more instead, hoping that the rental yield from the houses purchased will cover their massively increased mortgage payments. This development has, in turn, partly been sustained by the influx of migrant labour from Eastern Europe which has provided a rental market when most people in the UK have been encouraged to buy.

Unsustainable debt

How has this house price bubble been financed? Purely and simply through debt, and increasing amounts of it. The two best measurements of the growing indebtedness underpinning UK housing market rises are average incomes as a proportion of average house prices, and the average multiple of income allowed by banks and building societies when they agree mortgage levels with house buyers.

The average house price to average earnings ratio tends to increase notably during housing bubbles as prices rise at rates that far outstrip any growth in incomes. The long-term UK average has been for house prices to be around 3.5 times average earnings, though in the early-mid 1970s bubble this rose to over 4.5 times earnings, and in the late 1980s bubble to just under five times earnings. Today, it stands at nearly seven times average earnings.

The salary multiples which banks and building societies use to determine how much they will lend house purchasers when they grant mortgages has also increased massively. This had to happen because house prices have risen far more than wage increases. In the 1970s it was rare for financial institutions to issue mortgages that were greater than three times household income, then it went up to four times income in the 1980s until Abbey confirmed what many knew to be a reality last year when they admitted that they (and others) now lend at multiples of five times income, placing a massive financial burden on those with mortgages. What this huge indebtedness means is that the risk of default on mortgages, including mortgages for ‘buy-to-let’, is now significant; but this is a risk financial institutions have taken in the hope that rising house prices can be maintained forever.