House prices are bound to ‘readjust’. But not yet

I’m having an interesting week. I spent Tuesday flying around Scotland and Northumberland in a helicopter looking at forests and windfarms (more on this next week), and now I am hanging around at the National Association of Pension Funds conference in Edinburgh.

The first was obviously exciting, but the second is more interesting than it sounds. Yesterday, the big speaker was Blackrock’s Larry Fink (he’s “open” on Scottish independence and thinks private pension saving should be compulsory). And today it was Roger Bootle of Capital Economics, a commentator with whom we have a good amount of thinking in common.

I had a quick chat with Roger after his talk. I thought you might be interested in his view on house prices. We agreed that while there has clearly been a proper house price crash in much of the UK (the north, the southwest and so on), the average house-price-to-earnings ratio – at well over six times – is still ridiculously high relative to historical norms.

We agreed that while there are some structural reasons why the ratio might settle at a higher rate than in the past (dual income households being the main one), that absolutely doesn’t explain all of it.

If you accept that, you then have to agree with one of two things. Either the historical relationship has entirely and permanently broken down and is of “no value”, or the “market is heading for a nasty adjustment”. I think we all know which one of these Bootle agrees with. The question is simply when this might happen? The answer is not yet.


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That’s because with interest rates at their current all time lows (five years this week), mortgage payments as a percentage of take-home pay are just below their long-term average. At this level of interest rates, houses are affrordable.

The government has “thrown everything but the kitchen sink” at this market in their desperate attempt to revive it, says Bootle. They are being and “will be successful”. If you own houses or are buying houses, you have nothing to worry about for the “next few years”.

However, all good things must come to an end and there is “marked trouble ahead”. Right now, interest rates are at their lowest for 300 years. Yet mortgage payments as a percentage of take-home pay are only just below their long-term average. That means that the minute rates begin to rise (Bootle is forecasting late 2015 for this), they will rise above that average: “there is marked trouble ahead”.

However, the fact that rising rates will lead to a housing crash, which will in turn have “dire consequences” for everyone from the banks down, is hardly a secret among government officials and economists.

So, Bootle – like us – doesn’t expect it to happen quite like that. Instead, he sees interest rates rising very slowly and peaking out at 3% rather than 5-6% (at which point mortgage payments would be well over 50% of take-home pay).

That would mean high inflation and a falling pound. But it would also mean that anyone holding property would be unlikely to lose money in nominal terms. They’ll definitely lose in real (inflation-adjusted) terms. But that never feels quite so bad.

• If Bootle was choosing one place to put his own money today, he would, he tells me, choose UK equities. They aren’t expensive and – rather unexpectedly – he has high hopes for our future growth.

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14 Responses

  1. 06/03/2014, Shinsei1967 wrote

    “Either the historical relationship has entirely and permanently broken down and is of “no value”, or the “market is heading for a nasty adjustment”.”

    There’s a third possibility. Earnings could start rising (they’ve been flat since the banking crisis) and this would reduce the house price/earnings ratio back to “normal” levels.

    Surprised neither you nor Roger Bootle thought of this. Helicopter-related altitude sickness might be your excuse, what’s Roger’s ?

  2. 07/03/2014, Realist wrote

    For earnings to start rising, there has to be a proper recovery, not the false dawn we are seeing at the moment. That is why Merryn and Roger never entertained a third possibility.

  3. 07/03/2014, Boris MacDonut wrote

    Can’t see it myself. The interest on the average mortgage is the same as it was in 1993, £4,850 pa. We underwent said structural change in 1992,when the Tories retreated from the ERM. Before that house price to income had been 4.2 times, since it has been 5.6 .meanwhile we all got richer with more disposable income.

    • 13/03/2014, Tyler Durden wrote

      “We underwent said structural change in 1992,when the Tories retreated from the ERM.”

      This is total rubbish, and I seem to remember this being spouted before. To believe there was any kind of structural reform is pure fantasy.

      We left the ERM because our structurally poor economy depends on a currency that is being constantly devalued at a rate higher than just about any other.

      “meanwhile we all got richer with more disposable income.”

      Did we? Wow. You appear to be inhaling some fumes when you’re at the keyboard.

  4. 08/03/2014, Marko wrote

    Any article discussing house prices compared to historical norms is a lost cause.

    In the past 1 salary was used to secure a mortgage rather than 2 now.
    Interest rates are also extremely low compared to any other time in history.

    Unless households go back to one earner and interest rates rocket significantly I can’t see us going back to historical norms.

    Now, if the above two things were to happen, I would be a happy man living in the best house on the block.

  5. 08/03/2014, Marko wrote

    Real loss doesn’t feel bad for most mortgage owners because their asset is massively leaveraged.

    Will a bank lend joe public money to invest in equities??

  6. 08/03/2014, Marko wrote

    Real loss doesn’t feel bad for most mortgage owners because their asset is massively leveraged.

    Will a bank lend joe public money to invest in equities??

  7. 10/03/2014, CKP wrote

    When I sold my London house at the last peak in 2007 (heavily influenced by MW) I felt rather clever, with hindsight it was a costly mistake. I completely underestimated the following:

    1) The chronic and persistent lack of new supply in London, which has not been rectified by market forces, largely due to very restrictive planning regulation. Despite all the government talk, this has not changed.

    2) The massive and growing demand from economic migrants who flock to London, not just from the EU, but the rest of the UK and all the illegals on top. You can add in other groups such as students, genuine asylum seekers, oligarchs, rich Arabs/Chinese. The population within the M25 has probably grown by up to 2 million since 2000, truth is, no one really knows. What is for certain is that roads, trains, airports, schools and hospitals can no longer cope. Political instability in the EU and worldwide continues to attract more migrants, both rich and poor.

    3) The effect of globalisation and the emergence of London as the pre-eminent global city in Europe. The only other credible European competition are Paris and Frankfurt, for different reasons they do not come close. London’s competition is now limited to NYC, Shanghai, Hong Kong, Tokyo and possibly Singapore. This has meant lots more people with well paid jobs which comes with all the trickle down effects.

    4) The above fundamentals have not gone unnoticed by wealthy international investors who are continuing to pour money into acquiring London property

    5) The conviction and determination of all the government parties to increase property prices, through tax breaks, interest rate policy and banking intervention. Joe Bloggs cares nothing for the stock market, he salivates and obsesses about how much he can make on property. The government is determined not to let him down and lose his vote. There is a good case for re-introducing rent controls (USA has them) but given that the majority of voters own or aspire to own property this is unlikely to happen here.

    Like all growth stocks, the London housing market trades on a punchy valuation and there may be dips ahead, but the longer term trend is up. Given the huge transaction costs, the sensible play is buy and hold. Welcome to the new normal.

    • 10/03/2014, Boris MacDonut wrote

      If you sold an average london house in 2007, then money weeks poor advice cost you £450,000.

  8. 11/03/2014, Merryn wrote

    @Boris and @CKP That depends if you bought back in or not! We were very wrong on the London market of course. Prices fell for a year in nominal terms and a bit longer in real terms and then as we all know, soared. We underestimated the safe haven demand, the effect of the weak pound on foreign buyers, the effect of QE on real asset prices and the extraordinary determination of the government to prevent severe nominal house price falls. And @CKP may be right that only way is up.. but if so it isn’t a bit like a growth stock – all growth stocks turn into either quality stocks (in which case a reasonably yield is required) or value stocks in the end.

    • 12/03/2014, Boris MacDonut wrote

      Merryn. You underestimated the safe haven demand because you are economists,with little grasp of geopolitics.

  9. 13/03/2014, Realist wrote

    Admittedly with interest rates so low and government intervention, house prices will continue to go up. But what puzzles me, if it was that easy to keep prices high and the fact the government want prices high (for the feelgood factor), why didn’t they do this on every other house price crash in the past 100 years. Something doesn’t add up, somewhere down the line we are going to have to pay for this ‘false’ market.

    • 13/03/2014, CKP wrote

      Previous government monetary policy caused or worsened housing slumps as they raised interest rates:
      70s to tackle soaring inflation and capital flight. Strikes, 3 day week and IMF bailout.
      80s to defend the value of £ and to maintain the peg to the DeutschMark -ERM.
      Houses prices were not the overriding electoral issue as today:
      1. Buy to Let had yet to transfer swathes of council houses into private ownership
      2. Tenants were protected by rent controls and unaffected by property prices
      3. Far fewer voters owned homes including buy to let

      Another crash is certainly possible but a lot has changed.

  10. 13/03/2014, CKP wrote

    Correction: Buy to Let should read Right to Buy.

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