Are house prices in another bubble? How much will they go up by in the next five years? Merryn Somerset Webb chairs our Roundtable.
Merryn Somerset Webb: Let's start with Help to Buy. Good idea or bad idea?
James Wyatt: Cynical electioneering ploy by a government that has an election in 18 months' time and wants house prices to rise until then. I'm fairly disgusted by it.
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Merryn: Gary, you have a more positive view on this, don't you?
Gary Channon: Yes. We bought 12% of Barrett Developments in 2008, and with them and some of the other housebuilders and the House Builders' Federation, we've been lobbying the government to try to do something to counter what is happening in the banking industry.The banks haven't been lending, so there have been various schemes to help people to buy.
The problem isn't rates, it's raising deposits, so we have seen the shared equity schemes and so on. But none of this has really worked. So this new scheme takes it a little further.
I think it's a good thing the first stage boosted prices even in the secondary market (which was not actually affected by the scheme) it helped the housebuilders build more houses, but it also gave everything a psychological boost.
Help to Buy is really only meant as a temporary boost until the banks get back to doing what they normally do lending.
Henry Pryor: I agree with James. I think it's gerrymandering by any other name.
Ed Mead: The problem here is that the programme is Help to Buy, when what the UK actually needs is something called Build to Sell'. The first stage of Help to Buy did have some effect, in that it increased house builders' appetite for building more houses. So that was relatively successful. But the second bit? I'm with James in that I think it's a bit cynical.
The amount is absurd, for starters. Who on earth came up with the figure of £600,000? That's four times the national average! I run a business that has 18 offices in the centre of London and every single one of our offices, including the ones right in the middle, can benefit from Help to Buy.
People who buy in Kensington and Chelsea don't need any help to buy. But Help to Buy isn't as much of a freebie as some make out. It is still subject to status.
There are affordability tests and you have to be able to make the payments. This is just about people being able to get affordable mortgages with a small deposit. If the threshold was £300,000, I think it would be a perfectly good idea.
Adam Shaw: The evidence is telling us that Help to Buy may have already boosted prices. That's moving affordability further and further away we've got house prices rising even as real incomes are falling. If you look at the details of the scheme, it raises big questions.
If the government takes part of the proceeds of the sale of your house (20% in the first part of the scheme see below) and house prices rise, you won't benefit from the full rise. So how do you move up the ladder and buy your next property?
I'm also concerned about these affordability/stress tests that Ed has mentioned. The Treasury's guidance is that there must be strong affordability criteria. But these criteria are up to the individual banks, so in most cases we just don't know what they are.
I am concerned about the idea that we are intervening in commercial arrangements if the banks would not feel happy lending to people, is pushing them into it a good idea? It seems to me a ludicrous situation to have got ourselves into.
James Ferguson: The ideal time to buy a house is at the top of the interest-rate cycle. That's because as interest rates fall, your payments go down and the price of your asset goes up. Win win.
Ask anyone who bought a house sometime in the late 1980s and they will tell you all about it. Then mortgage rates in the UK were near a 300-year high. Now they're at a 320-year low. So you've had the best move in 300 years.
A rational buyer who is conscious of those sorts of things would say to themselves that the very worst time to buy is surely at the bottom of the interest-rate cycle, especially a cycle that has overshot to a 320-year low.
What will happen to it in the future is two things: rates will go up, so payments will go up, and at the same time the value of the asset will go down. Lose lose.
People tend to anchor', looking at today's interest rates. But you can't do that today not at 320-year lows. So trying to encourage people to buy at the moment is not just a petty political game. I think it's really, truly morally unsound.
You're going to bankrupt every person who takes advantage of this deal. Bump up the prices, new buyers get forced in at the top, and everyone gets crucified when the prices normalise.
Gary: But there is surely a broader thing to say about home ownership. Houses are not a take it or leave it' asset. Shelter is something that people are going to have anyway. You're either a landlord or you're a tenant.
What the banks have been doing is effectively excluding a large part of society that would in normal market banking conditions be able to get on the housing market. Help to Buy just fixes that.
Houses are going to be bought anyway by landlords or people with access to money. There are very few defaults in mortgages, so the taxpayer isn't really at risk here.
James F: We get very, very few defaults at super low interest rates. But that doesn't mean people aren't in trouble. The records show that 8% of mortgages are in forbearance. It's better to say that we've had very few defaults yet.
Gary: In 1989, rates went up to 15%. The worst loss year for the banking system was 0.8%. In this cycle it's been 0.4%.
James F: But that's the point. In the late 1980s rates were very, very high. And as we went into a downturn, rates were slashed. People who might have defaulted got constantly lower mortgage payments. Interest rates were cut and cut and cut. The stress was taken out of the system. We can't cut rates now.
Gary: But there's no correlation between rates and default rates. It's all unemployment. So if people don't lose their jobs, they carry on paying the mortgage, and in the same way that when petrol goes up, people pay more for their petrol, when their mortgage goes up, they pay more for their mortgage. They cut other things. Some people will be harmed by this policy people who lose their jobs and end up losing their house. But overall it is a social good.
Henry: So you're saying it's a social good to be able to buy a house at a 320-year low interest rate?
Gary: We've looked at every developed market going back 50 to 100 years and we find no link between incomes and socioeconomic factors and house prices. It's all supply and demand.
James F: It's an enormous leap from saying there's no link between incomes and house prices to interest rates and house prices.
Gary: Look to the US. The interest rate and the government is the same all over. So why are house prices so different? Prices in Boston and New York are the highest, yet they fell the least. Why? Because they've got zoning policies in Boston, just like in the UK.
And look at where the most houses were built relative to household formation. They fell the most. The more undersupplied the market is, the more expensive it is.
Adam: So what you're saying is that if Help to Buy is successful in boosting building and hence the supply of houses in Britain, its actual success will burst the UK housing bubble?
Merryn: We need to go back to the term bubble'. I don't think all of you actually believe there is a housing bubble in Britain.
Gary: I don't.
Ed: No, I don't. We don't have a bubble in London, for example. What we have is a very, very thin market producing anomalies. The press say London is fantastic it's not. There's no volume no one is selling anything in central London and with no transactions I don't see how on earth you can call it a bubble and even prices aren't all that.
Prime central London has gained 40% over the last five years. That sounds high, but half of it is just inflation (which has been about 20%). So real gains are about 20%. It's not that high.
Henry: Because the few transactions that are occurring are occurring at astronomical levels.
Ed: But there are very few transactions.
Henry: But they are 100% of the transactions.
Ed: But that's not a healthy market.
Merryn: Bubble markets aren't healthy, but they are usually characterised by very low levels of transactions. I suppose a key question is does everything that comes to the market sell at its asking price?
Ed: No. Asking prices are probably 15% over what anybody will buy at. Rich people aren't thick. They didn't get rich by being thick. If they think the market's too high, they'll go. And those prices are too high.
Merryn: OK. So can we say there's a bubble in asking prices, but not in real prices?
Ed: Yes. That is a very fair comment. In London, yes. In the rest of the country, however, there isn't one at all. Real prices are way down.
Gary: For me, a bubble is prices moving sharply away from intrinsic value driven by speculative demand rather than by buyers who need the underlying asset. We currently have eight researchers in the field visiting building sites all the time, and we do not find much evidence of speculation. Outside London the people who are buying seem to be buying to consume.
Ed: What about the record number of buy-to-let mortgages? These are speculators.
Gary: I think they're buying for the rent.
Ed: Not in London they aren't. The yields are wafer thin.
Gary: Median house prices are £170,000 and a median rent is about £9,000 a year, so average net rent is about 5%. That doesn't look overvalued when you consider the alternatives. There may be pockets of bubble in London, but that's all.
The worry is when it is the other way about when the enterprise becomes a speculative bubble and most demand is temporary. That gives you huge mis-allocation of capital in housing terms, overbuilding. We just don't have that. Instead, we have a supply and demand imbalance that will raise prices to the level where it tempers the demand to match what is available.
Our discount rate (7.7%) says that average house prices should be £340,000. For a landlord, long-term investor, house prices overall nationally look very attractive.
Merryn: So we're crazy not to be going out and taking out ten buy-to-let mortgages each and buying portfolios of flats around the outskirts of London.
Gary: So it would seem.
James F: You said before that house prices weren't about interest rates, but what you have just said about yields surely relies absolutely on interest rates?
Gary: On rents. Look at rents over 100 years. Rents have consumed on average about 20% of people's income, so they've matched growth in average earnings. So we've got an inflation target of 2%. We've got long-term productivity growth of 1%, so I should get 3% nominal growth. So if I buy a house now, what will I get? It works out at about 7.7%.
Is that attractive to me, given I'll also be protected against spikes in inflation? Well, what are my alternatives? I can get a government index-linked gilt at 1%, or a gilt without inflation protection at 3.5%. That doesn't make housing look over-priced.
James F: What you're saying is that housing is not relatively unattractively priced compared to other yields. I don't think any of us would disagree. But I'm saying that if house prices are a function of interest rates (and I think they are), then house prices will likewise revert.
Gary: They're not a function of interest rates.
James F: If interest rates went up by 300 basis points, what would happen? Would values remain unchanged?
Gary: I'm not saying where prices will go. I'm judging whether it is cheap or expensive right now and finding that there is no bubble.
James F: If you define a bubble as everything operating relative to an anchor, I can see that. Relative to the anchor of super-low interest rates, I agree housing is not ridiculous. But that anchor isn't static. Interest rates are going to mean-revert that means rise a lot.
Gary: We've not found any evidence that suggests there's a link between house prices and interest rates.
James F: But there is. Over time we know that people can spend roughly 20% of their disposable income on housing costs. So if nominal incomes go up four times or so, house prices should be four times higher. It isn't exactly four times it hovers around there and some things change it up or down.
Taxes can, but the one that seems to change it the most, theoretically and practically speaking, is interest rates.
Gary: Only one-third of houses in the UK have a mortgage on them. Most houses don't have a mortgage on them so they can't be a function of interest rates. You retire and your income collapses, but if you don't have a mortgage that makes no difference.
Henry: Not until they or their heirs have to sell. Then the next generation buy it and they are buying with a mortgage. The sale price the one that matters here is still about ability to pay, and hence rates.
First-time buyers push themselves historically on average they spend 34% of their disposable income on their mortgage. So we've got a long-run average model for what the people who keep the whole cycle going can spend.
The first-time buyer's household disposable income is about £25,000. Do the maths and you'll find that they shouldn't be spending much more than £95,000 on a house. This is what matters: what the 80%-90% of people buying their first or second house are willing or able to pay.
James W: I want to come back to this question of bubble or no bubble. We still have a nationwide house-price-to-earnings ratio of over five times when historically it's around 3.8.People pay for their houses out of earnings and as Adam says average earnings are taking a real battering at the moment because of inflation.
So prices are high, transactions, as Ed said, are very low and it is wrong, in London at least, to say that people are buying property solely to live in.
I was speaking to several residential developers, and they're selling 99% to foreigners. If you're a valuer like me, you go in a year, two years later, and they haven't even stepped foot in them. They're just buying for capital appreciation, and because they regard London as a safety deposit box. They're locking up their money.
That cuts supply too. In pockets of London at night, you'll find that maybe only a quarter of the lights are turned on. I keep going to see properties that people only go into a week or two a year. Outside London, though, I would agree that we have a supply problem. There's no reason not to open up the green belt, but the government won't do it.
Merryn: So what do you do to stop the speculation in London?
James W: Property taxes in the UK are very low in international terms for non-resident owners. So why not bring in a capital gains tax for them?
Merryn: So you're pretty sure that this capital gains tax will come in?
James W: No. I'm not saying sure. I'm sure there will be further taxation of property. We're already overtaxed on income. During the lifetime of this parliament, the national debt will have almost doubled. Whoever gets in Labour, Tory, Coalition they will have to tax wealth.
The biggest gains over the last credit cycle have gone to people with property, and you can't avoid property taxes. I hate taxes. But I can see it coming in, and I think we're also going to be seeing another tax on property.
James F: It should be buy-to-let investors who see reduced tax allowances. Right now anyone buying to let has an immediate financial advantage over an owner-occupier buyer. They can get an interest-only mortgage and offset the lot against tax. How can a first-time buyer compete?
Adam: On the question of the bubble, it does strike me that it is worth doing a kind of sense check on this. Look outside the economic numbers to what is really going on.
For Panorama, we filmed with a bloke in full-time employment who gets to the end of the week and has £6 to feed his family for the night. According to Shelter there are many areas where 90% of the properties are unaffordable by the person earning an average income.
It seems a very odd situation where huge numbers of people are working but not able to buy. You can imagine this bursting and it then all seeming so obvious in retrospect. Forget looking at the numbers just go into the pub and ask people.
It might make sense here talking about numbers to say there may not be a bubble, but if I walk down the road and talk to someone, or indeed a lot of people we've got in our programme, who go to work and cannot afford to buy, it looks different.
James F: It's very similar to the dotcom bubble. That was sustained because people would base the valuation of one thing say Nortel's fibre-optics division on the value of another, say JDS Uniphase. Then both would turn out to be useless.
Gary: That's not entirely fair rents have risen as well as prices, so the value of houses is real and has gone up.
Ed: I suppose the trouble is that we are talking about houses as a rational investment. But they are much more than that. To the majority of the population, this is just where they live.
James W: So the real question is just about whether we should be trying to engineer the market.
Ed: The only thing you can do to change the housing market is to build more houses.
James F: No. This is my entire point there's one other thing you can do. Revert interest rates. Job done. Politicians won't do that until they have to, as it would massively increase the cost of one group's outgoings. Demand at current prices would collapse (new buyers couldn't afford today's prices at tomorrow's interest rates), and hence so would prices.
Gary: I don't see it happening like that. What will happen is the houses will end up in the hands of non-occupiers, like Switzerland, where 65% are owned by wealthy people and business. People will become renters.
Help to Buy might change a bit at the margin, but the most realistic outcome over the next 20 years is that the proportion of people who are owner-occupiers will just keep falling.
James F: You may not see it, but that's what happened on the way up. The more interest rates fell, the more house prices rose. That's on record. You don't make houses more affordable by cutting rates. You make them more expensive.
Ed: It has to come back to building. If they're asked a sensible question, people would say we need to build more houses.
Gary: Yes, I agree with that completely.
Merryn: If you look at London you will see that, contrary to popular belief, there are thousands of units going up. High prices do drive supply free up planning just a little outside London and the building will happen.
Ed: On green fields as well
Adam: I spoke to the chairman of the National Federation of House Builders yesterday and he said the entire problem is to do with planning.
Gary: That's not what the builders are telling their owners right now. All of them are planning to grow their volumes by between 5% and 10%.
Henry: So in ten years' time, how many new houses could we conceivably be building every year?
Henry: Right, so not nearly enough. We need 250,000 a year.
Ed: We've clearly got a supply problem in the UK market, but to me what matters are the corruptions perpetrated on this market by policy with extreme interest rates, tax breaks for buy-to-let, etc.
These are distorting the market and when things go back to normal it will be really nasty. Rates go up three percentage points and property prices could as much as half.
Gary: Except that rates are going to rise as the economy is picking up. That means unemployment will be falling. One final point to make on housing is that a mortgage is the most wonderful saving vehicle, because it forces people to save.
Put money in a bank and you have to draw it out. But when you pay down your mortgage, you go to a lot of lengths to ensure you meet those payments, otherwise you lose your home. So this forces people to save in an asset that they can check on every day.
Henry: One final thing on London. My clients are worried about two things here the mansion tax and social unrest. You can't ignore the social impact of everything we're discussing and we've seen all too recently exactly what can happen when people get angry.
Income inequality is the highest it's been in the UK for decades. It is worth noting that you can still buy a house in Enfield for 10% less than in the neighbouring borough. That's because people still remember the riots two years ago. The property market still bears the scars.
Merryn: How much do you think British house prices on average will change in the next one and five years in nominal terms (not accounting for inflation)?
Ed: They'll go up by 5% and 15%.
Gary: 10% and 25%.
James W: 8% next year and in five years' time I think we'll be flat in nominal terms.
Merryn: Does anybody have particularly different forecasts for central London?
Ed: Prime southeast and prime central London I still think that'll be up, I think it'll be 10% this time next year, but then I think it's going to ease off, so I would have said going forward you're going to be talking about relatively flat in five years' time.
Merryn: Brilliant, well let's nip out and buy some flats now, shall we? Thank you everyone.
How Help to Buy works
Help to Buy covers two separate schemes. The first phase, launched in April, is aimed at first-time buyers, and those buying new houses, up to a total value of £600,000. It gives people an equity loan worth 20% of the value of their house, in return for an equal stake in the property.
This loan is repayable after the house is sold or the homeowner chooses to buy the equity back at market prices. To encourage buyback, the government will charge owners a fee of 1.75% after the first five years, which then increases by 1% above the rate of inflation.
The second scheme guarantees the first 15% of a mortgage with a loan to value of between 80% and 95% on British houses up to £600,000 (for a small fee). This means the lender can offer a 95% mortgage while only risking 80% of the property's value.
The homeowner is not allowed to own stakes in any other properties, sub-let the house, or use the scheme as part of a shared equity deal. Furthermore, the mortgage must be a repayment mortgage, not an interest-only one. While this scheme was due to start at the beginning of next year, it has been brought forward to October.
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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