Britain’s housing market is an unexploded economic bomb

UK house prices saw their biggest fall in 18 months in April, reckons the Halifax.

Yesterday’s report from the lender suggested that house prices fell by 3.7% in the three months to April, compared to the year earlier. And month-on-month, prices were down by 1.4%. The average house price – by this measure at least – is now £160,395.

Halifax economist Martin Ellis preferred to describe this as “some downward movement in prices”, which shows just how averse property pundits are to using the word “falls”. But there’s no doubt that this is a pretty hefty decline.

However, it’s nowhere near enough to make houses affordable yet – and that’s bad news for the rest of the economy.

Are house prices set for a long slow decline?

Not every property survey is quite as gloomy as the Halifax’s most recent one. Surveyors and estate agents are more optimistic than anyone had expected. According to the Royal Institution of Chartered Surveyors (Rics), the majority are still seeing house prices fall. But the reading for April came in at -21, rather than the -23 expected. And that’s the most upbeat they’ve been since July 2010.

Perhaps this isn’t too surprising. You’d expect there to be a bit of a ‘spring bounce’ in the market. But other aspects of the report suggest that the market is about to run into more quicksand.

The number of buyers on estate agents’ books has stopped falling. But the number of homes on the market is rapidly rising. The percentage of agents seeing a rise in sellers came in at 18, compared to just four in March. As usual, when you have supply rising faster than demand, that suggests prices should fall.

And house prices remain unaffordable on historic measures. As Allister Heath in City AM points out, the average house now costs around 4.4 times the average income, still well above the “post-1983 average of 4.0 times”. After the early 1990s crash, “prices fell to 3.1 times earnings”.

So it’s hard to believe that house prices are set to rise any time soon. It’s just a question of how much further they’ll fall. A recent report from the National Institute of Economic and Social Research (NIESR) suggested that real – ie inflation-adjusted – prices will slide by 10.5% by 2015.

NIESR expects inflation to do most of the dirty work. For example, this year it expects nominal house prices to be flat, but for CPI inflation to come in at 4.5%. It doesn’t sound disastrous, but if it happens, “it will be the longest period of falling house prices that we have seen”, says NIESR.

Or will we face a short sharp plunge?

The idea that inflation will bring house prices back to affordability is probably comforting for property bulls. Sure, it’s not painless, but it’s less painful than an almighty crash. But to me, there’s a problem with this notion. And you can sum it up by comparing the British housing market to the US one.

US house prices are still falling. In fact, they’re in the midst of a double-dip right now. And that could continue for some time.

What was the difference between Britain and the US? It comes down to the way mortgages are affected by central bank policy in each country. In the US, borrowing costs for homeowners are linked to long-term rates, rather than short-term ones. So the Federal Reserve, despite its very best efforts, could only do so much for homeowners.

Even when the Federal funds rate was slashed to 0.5%, the monthly bill for most homeowners didn’t drop as much. So in effect, there was no real bail-out for homeowners. And that’s been painful.

In Britain of course, when the Bank of England slashed rates to 0.5%, many homeowners saw their home loan payments plunge. That put a floor under the housing market, and prevented a surge on repossessions. However, it now leaves us in a difficult position. Here’s why.

High house prices will be a drag on the UK economy

The US may not raise interest rates for quite some time. But when the time comes for rates to rise, the one thing the Fed won’t have to worry about is causing a surge in ‘foreclosures’ and a fresh collapse in prices. Because property in the US is now cheap on many measures.

Sure, there’s a tremendous backlog and over-supply of repossessed homes to get through, so prices may keep falling for a while. But in effect, the worst of the shock is over. I suspect that anyone who had the money and the inclination to buy now would probably turn a profit at some point in the future. And when a recovery eventually comes, US consumers will benefit from cheap housing.

Britain has yet to go through this ‘clearing’ process. We’re going to have this millstone of over-priced housing dangling around the neck of our economy for a long time. The Bank of England can’t raise interest rates for fear of crippling the consumer and therefore the banking sector, by sparking another slide in house prices.

This is a serious handicap. For inflation to bring house prices back in line with earnings quickly, then wages have to start rising more rapidly than they are now. But if that happens, then the Bank will have no choice but to raise rates. And that in turn will hit house prices. On the other hand, if wages remain stagnant and the cost of living keeps rising, that’ll just put more pressure on consumers and homeowners. That’s not a recipe for strong house prices either.

In short, British house prices are still unaffordable. And the economy would have to tread a remarkably steady path between inflation and stagnation over the next four years for prices to come back into line simply through gentle erosion. I don’t think we can expect that degree of stability – I’d be surprised if we don’t get a second leg of the house price crash well before then. In the meantime, you can keep an eye on what’s going on with house prices using our housing market indicators.

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  • neko

    Interesting, but how is the London market? Immune because of the Safe haven status from the emerging market buyers, right? that ‘s what estate agents are saying…

  • NEil

    London market, indeed the south east seems to be fine so far. Some areas are easing a bit but the places where I’d like to live are totally unaffordable so I am preparing myself for a life in the sticks.

    N4, N7, N8, N1, N5 for are more expensive than ever from what I can tell. I’m looking at E5. Even mainstream hackney,dalston are out of reach too all but the 200k+ households. You still can’t buy 80sq m flat with outside space (non-council) for under 400K in zone 1,2.

  • Amanda

    We are an agent in the South of England and we are definitely seeing an increase in sellers and shortage of buyers. The properties that are selling are those that are priced competitively – the vendors who actually listen to us. Prices are definitely coming down, although only slightly at the moment.

  • Simon

    Money Week has been predicting house price Armageddon ever since I can remember – and the more it is delayed the more strident the comments become. In this instance the comments (as ever) make selective use of facts – ignoring anything that does not support the house price crash predictions. In this case the article ignores what Halifax has to say about supply and demand – “Modest tightening in housing market conditions. The ratio of house sales to the stock of unsold properties on surveyors’ books – according to the RICS monthly survey – is a measure of market conditions that has historically proved to be a good predictor of short-term house price movements. This ratio increased slightly in March for the second consecutive month, suggesting a modest tightening in market conditions.

  • Mark Parker

    Note that house prices falling in inflation-adjusted, ie real, terms won’t necessarily make houses more affordable. Typically wages rise faster than inflation, but not at the moment. Wages are rising at 2% while inflation is around 5%. Ever year average buying power is falling by 3%! This year people can afford to buy 3% less; next year 6% less; and the year after that 9% less.

    These numbers are approximate of course but they sh0w that our economic future is dire unless the Bank of England brings inflation under control.

    It doesn’t seem likely that the BoE will bite the inflation bullet until it’s too late, then there will have to be sharp rise in the base rate.

    Letting inflation rip isn’t an option. The wider the wages-inflation gap the faster the economy will stall. And a stalled economy reduces wages even more. (While not affecting inflation which is “imported”.)

  • Neil

    I’ve just skimmed the RICS survey for comments from London EAs. From a bear perspective the outlook is very depressing. Battersea for example is 10% higher than 2007 one EA was saying.

    Anecdotal evidence tells me new developments are selling fast areas close to the city. There’s really no hope of a return to a sensible earnings / price ratio in London I fear.

    I am doing a Merryn and going to take the plunge because I am so sick of renting.

  • Ellen

    @ Neil. I also live in London. I think the two things distorting house prices are low interest rates and restricted lending by the banks. It means the only people who need to sell are probably not doing it completely for financial reasons (death, divorce, downsizing) but not debt. But the restricted lending also keeps buyers very low. All these percentages and statistics I believe to be misleading because the real issue is not so much how much houses are selling for but the very low number of houses being sold. There are a great deal on properties on the market where the vendors are just punting it because they know house prices are as high as they are going to go. Genuine vendor who intend selling should take good offers. There are houses round our way selling for up to 200k below the original asking prices. So be careful not to offer too much.

  • Steve

    I have a question that I hope those more knowlegable about these things than me might be able to answer. I have read other articles that talk about us not having enough houses I.e there is a lack of supply. How does this fit in to the equation or does it depend what type/size of house you are talking about? Also if people can’t afford the houses they will go in to rental so does this mean the prices of smaller houses and flats will at least remain steady or rise as they are in demand by investors??? Any thoughts appreciated.

  • Steve

    “For inflation to bring house prices back in line with earnings quickly, then wages have to start rising more rapidly than they are now. But if that happens, then the Bank will have no choice but to raise rates. And that in turn will hit house prices.”
    I don’t understand this, can you be more clear? Surely if rates rise, more people have to sell and prices drop, meaning that prices would be brought back in line with earnings even quicker?

  • drama queen

    ” the average house now costs around 4.4 times the average income, still well above the “post-1983 average of 4.0 times”. After the early 1990s crash, “prices fell to 3.1 times earnings”.
    I don’t understand the maths here: average house price = 160,000, average wages (more or less) £25,ooo and you come up with a house price of 4.4 times the average wage when it 6x or more. House prices always used to be measured against a SINGLE wage earner at 3.5x or at 3 x joint (or even lower at the bottom of the last crash). This would make the average house at least 50% overvalued, which I believe they are. If you think this kind of drop is not possible look at Ireland and the States.

  • James

    Average UK salary is not the same as average house buyer’s salary. The latter is higher, hence the lower multiples given.

    (For the record, I’m a house price bear and predict the bottom to occur around 2014/2015 based on UK demographics and previous peaks/troughs).

  • Keith

    Does anyone know where I can get an updated Affability chart from that was shown in this article in 2009?

  • Marky t

    Why are London house prices holding up?

    I honestly don’t understand why people are still asking this – QE-ZIRP and a suspension of normal accounting rules for banks. Without these measures the big banks would be BUST and a lot of London-based bankers would be unemployed! Remember that there is unprecedented levels of cheap money sloshing around – and 50% of all bank profits go straight out in salaries and bonuses. Mind boggling but true.

    Can it last? With so many systemic risks at large (sovereign debt in Europe, US debt downgrades, rampant global inflation) one has to conclude that life in the banking industry is perilous to say the least and that when they hit the skids London HPs will eventually be reaquainted with gravity. And when they fall they will fall hard!

  • Keith

    Does anyone know where I can get an updated Affability chart from that was shown in this article in 2009?

  • Keith

    Does anyone know where I can get an updated Affability chart from that was shown in this article in 2009?

  • Cherios

    The average salary the use is actually the average salary of the primary wage earner, a single white male…. Which is 29 k. Their maths is still crap though.

    An increase in supply would drop prices in any normal economy, but house building is tightly controlled. It’s supply is restricted. There are other problems too; developers have to buy land and pay money upfront. If houses are overpriced, they run a huge risk. So when houses go up in price, and are likely to fall, developers pull out and the supply is further constricted, increasing the price still further. Also; as this happens the developers who are still in the Market see more profit from land appreciation than in building houses. So they have a moral hazard. They can continue the game, hoarding land…

    Uk is not short of land. But definitely short of decent homes.

  • Luke Freeman

    The affordability calculation needs to take into account the fact that the cost of finance is at a very low level. You should not compare multiples of earnings to average house prices without taking the cost of finance into account. Otherwise the calculation is meaningless in my view.

  • Clive

    “As Allister Heath in City AM points out, the average house now costs around 4.4 times the average income, still well above the “post-1983 average of 4.0 times”. After the early 1990s crash, “prices fell to 3.1 times earnings”.

    If you say the national average house price is £160K since when has the national average income been £36K??

    On this formula, average house prices are really 6.4 times the national average earnings!

    £36K is the average for London saleries, but I think you will find that average London house prices are much high than £160K!!

  • ACM

    Not re: property ……… but, I read that Soros has already sold gold and Jim Mellon [Wake-Up! quarterly] advises selling gold and buying US dollars ????
    Comments please.

  • Marky t

    Ah, supply and demand – that old Estate agent chestnut!

    Does anyone have data that shows (number of buyers divided by number of sellers) vs house prices are prefectly correlated over a substantial period of time? I strongly suspect they are not, hence this argument is completely BOGUS!

    Don’t believe the hype. If anything it’s about the supply and demand of credit – and it should be clear what has happened to that!

  • DavePage

    Like Neil, I too am sick of renting (and watching while the BoE takes the interest from my savings to subsidise other people’s mortgages) and have also decided to “take the plunge”.

    The difference is I am taking that plunge across the Atlantic, in the US, where this article informs us (correctly, in my experience) that prices are still falling and closer to fair value.

    I decided to do this after watching house prices outstrip my earnings for a decade (thanks Gordon Brown), and elected to quit the country instead. To my surprise, I found a much better society in my new home, and now read about the daily horrors in the UK safe in the knowledge that it’s the best move I ever made.

  • Will Hicks

    I’d love prices to crash down another 20%, but I’m afraid Mr Stepek is beginning to become a bit of a stopped clock with this. It’s clear that the BoE are going to keep IRs near zero as long as it takes the banks to recover [as most are technically bust]. Could be looking at a Japan scenario IMHO. In the mean time, the various average house price indices are been suspended by the wall of foreign cash that is been washed in London property.

    So what we really need is some proper market regulation and a Land Value Tax to force the Land Owners [Toffs] to sell their 1000s acres they use to suck in EU subsidies.

  • Specky

    “If you say the national average house price is £160K since when has the national average income been £36K??

    On this formula, average house prices are really 6.4 times the national average earnings!

    £36K is the average for London saleries, but I think you will find that average London house prices are much high than £160K!!”

    I’ve also had great trouble working out exactly where they get this ratio from. The nearest I can get is that they use the London Average for the salary and the National Average for the house price!! But this would be daft so I must be missing something. Anybody care to enlighten us?

  • Raj

    I have been looking for property from last 2 years. Still the asking price for number of houses are unrealistic. Number of sellers are expecting prices we had in 2007. Only these kind of property available in the Market. People having realistic expectations are still selling.

  • Guy H

    I agree with Nick….and John.
    House prices can only come down in the short to medium term. Furthermore, estate agents and Mortgage providers are putting a preposterous spin on the subject, saying its a “mixed picture”. “Mixed picture” can mean anything – selling properties in London as well as in County Durham is always gping to be a “mixed picture”. In reality its bad in London and appalling north of the Ouse. I predict a 20% fall in prices in the next 12 months as a national average.

  • Julian

    Where is there an average house at £160,000. That is the price of a flat in my area.
    All I know is I need more like 7x salary minimum to get anything in my immediate area.
    Add to that, for a decent mortgage rate you need at least 20% deposit. Even on £160,000 that’s £32,000 plus costs.
    Houses are massively overpriced, and no matter how you massage or distort buying and selling with home equity loans etc, this is never affordable.
    50% drop is the minimum needed to make this viable.
    The government and BofE know that the economy depends on high house prices (a general feeling of wealth), so they’ll do everything they can to keep the status quo.
    Just wait for all the self cert mortgage holders coming to the end of their current reduced rates only to find they can’t get anything affordable to remortgage to and have no option but to swallow obscene standard variable rates or sell their property and down size.

  • NKA

    Amanda, as you are an Agent can you please answer me this: how are Agents managing to survive this recession given that your main source of income (commission on sales) has been so badly hit ? Logically I would have expected Agents to be lowering house prices drastically in order to stimulate the cash streams necessary to survive. Who owns the big Estate Agents ?

  • Deano

    When house price fall, rental yields increase, and every single house in the uk has a rental yield potential. When a rental yield is higher than inflation surely it becomes a good investment even if initially the capital value falls-after all isn’t rental yield cash flow, king!

  • Ashley

    London market is high due to overseas buyers. The pound has fallen as the Government is lowering the pound against other currencies to increase exports and help the recovery. So for overseas buyers if the pound has fallen 20% against their currency the property is now 20% cheaper for them at the same price as in 2007.

    Prices are so over valued it is very depressing for me. The banks know a hit is coming to their balance sheet but the Government are basically giving them time to fatten up before they have to realise these losses to decrease the risk of them going bust and needed additional help.

    Inflation needs to be controlled as correctly stated purchasing power is less so mortgage payments will be a larger percentage of take home pay. Either way house prices will fall as wage inflation is very low (and has been since 2008 bar anyone who works for the public sector – so pleased they are stating to be pulled into the real world!)

  • Elvis Presley

    Massive influx of people during the last 15 years and we didn’t build the houses, hospitals, schools for them. Nothing wrong with immigration (providing the population wants it), but at least plan for it! Build more houses. Or stop the inflow. But do something!

  • Gamesinvestor

    I really don’t know why everone keeps stating that property prices are at 4.4 times average income. This is not the case. The average salary in the UK is approximately £24,000. The average house price is now £160,000 according to the lastest Halifax data. So this means 6.6 times average income. The historic average is approx 3.5 times, and this is based on one salary not on any multiple of 2 or more incomes in a household. On this basis to get back to 3.5X we would need to see house price average at £84K.

  • Michael Lewis

    If you look at the graph of house prices its suprising how close it fits the pattern of a buble:

    We seem to be right at the start of the ‘Fear’ phase.

  • Alex

    Gamesinvestor, that’s the problem of using long term historic data/averages to try and model the present/future. The fact is that today it’s unusual for both partners in a relationship not to work, and even after children most women return to work.

    Using an average of £24k the average house is just over 3 times the average household income at £160k. Past averages based in a world where a mans wage was the household income point to a multiple of 3.5 for a single adult household or 2.5 for a 2 adult household with the lower ratio reflecting banks assumption that a wife would give up work.

    So contrary to your argument the current prices are if anything bang on the historic average, taking social changes into account.

  • DW

    “The fact is that today it’s unusual for both partners in a relationship not to work, and even after children most women return to work. “

    So Alex, are you saying that you believe two income households are substantially m0ore common now than they were 10 or 20 years ago? I certainly dont think thats the case and multiples were mostly betwen the 3x and 4x range in the 90s?

  • Dean

    House prices as far as I can see are coming down, but some sellers, as pointed out in some posts are still living in 2007. A raft of houses in the good places to live my area, have now come on to the market and selling reasonably well, but I still see some property’s that have been standing for 4 years with their “for sale” signs up. Seems the owners of Property’s that have been on the longest have been aseep for the past few years.
    As for interest rates, they’ll shoot up next year, Iv’e just switched to the one account and shoved all my cash in there, so……no morgate left but still can get my hands on the cash if i wish, and when we see swathes of panicked or repo’s sellers next year, then i’ll buy.

  • Rob Fisher

    The Australian property crash is following the UK crash like clockwork. Here in Australia we are just 2-3 years behind.

    12 months ago there was complete denial that real estate was in trouble, but now the realization is beginning to dawn on many that something terribly serious is about to occur in Australia. Australian housing is vastly, dramatically overpriced, by all reasonable measures. Anyone will see from the excellent blogs on just how overvalued Australian housing really is:

    The bigger the boom, the bigger the bust, and the property boom that began in Australia in the nineties evolved into the greatest real estate bubble known to mankind. Long live the new new paradigm, where an average family can finally afford a decent home in Australia. It’s been a long time coming, but soon it will be time for the bears to party.

    Rob Fisher.

  • Night Raider

    Alex, why do you think more households now have two earners? Could it be because housing costs are so high? If these fall, then i’m sure you would see less mothers returning to the work place. I know a lot of wives etc that certainly would not be working after their second child were it not for the pressure to pay huge mortgages. I’d be a little slower in jumping to the ‘this time its different’ camp. It rarely is. In my opinion, two earning households are a reaction to high house prices, not the other way round. It may be a social change, but it’s probably not one that every family wants and it can easily be reversed if pressures on households subside.

  • Alex

    Night Raider, I must say I see it totally the other way around. It is the greater income from two earner households that enabled house prices to be bid up to the maximum amount a 2 income household can afford. I agree that the consequence is that alot of women with children are now ‘trapped’ into working by high house prices. But that’s the way it is.

    What I do believe is that house prices peaked in 2007 at a level they will never see again ( in real terms ) because women going out to work was a one off demographic adjustment, the next major demographic change will be a mass die off of hte Baby Boomers in about 20-30 years, which will have a profound impact upon house prices.

  • 888mate

    M. King. (notes to self for future reference):
    1) too low interest rates plus too easy credit leads to bad investment decisions. (May be able to use this thought to discourage bank speculation and public over exuberence)
    2) short term capital gains not the same as long term economic growth

  • Bob

    I am seeing little sign of falling askin prices in Swansea – stuff coming on the market now comes on often for higher than in 2007 peak.

    EAs tend to be still in denial land, but some admit the housing market is getting worse. It just seems that sellers, EAs and those buying are living in some fantasy world.

    Houses I looked at last year are now on the market for about 50K to 70K more than last year. It is as if people are economically in denial about the UK economy.

    Twice today I heard 2 different EA firms tell sellers and buyers that it was all the fault of banks.

  • Eco Nomics

    Interesting and informative article , good comments
    but the current economic situation can easily be summarised in 6 words…….

    Mervyn King is a useless idiot.

  • robin hood

    stop wining about high house prices,lifes to short to sign up to a 30year morgage for an “asset”.
    Its the way the leaders make the young work there prime,you know tell the people how there supposed to live,the big house,the big car,the big tv ect.Give them the unattainable dream then muggins makes the rich richer.So for the young renters out there,dreaming of all of the above dont rent, dont buy,live in a caravan,boat,tent anything watch your bank balence grow then spend the winter in the tropics.
    Stop watching the properganda start living, your dead for a very long time.

  • NickT, Aldershot

    Another great article from MW – just as great as the one that convinced me to buy HMV shares. Talks complete sense, thoroughly logical, built on sound analysis. The same qualities have been present in all the MW articles spelling impending doom in the housing market over the last few years. Shame markets are not built on the same level of rational thought, logistic, and financial acumen.

    If I live long enough, I may actually get to see the great UK property crash, though I suspect I won’t.

  • Lulu’

    In June 2005 my council flat in N7 was valued 185,000,in June 2011 ithas been valued 245,000 an increase in price of 32.5%……..
    Could this be possible?
    Everybody’s talking about a fall of prices in the house Market, is it only my council property that has gone up???
    Can anyone please give me an answer, do you think this is correct??????
    Many thanks!!!!

  • Biscuitbum

    The house in Suffolk, I nearly purchased in 2010 has been on the market for three years and is now on its third agent, jointly with the second one. I bought the property directly opposite, and check rightmove daily. I see the same properties appearing month after month, mostly with no reductions. Denial is rife.