Has the house price crash finally begun?

Is the UK house price crash on the way? James Ferguson thinks it's time to take the risk of a property crash seriously…

House prices in London have started to fall. And history suggests that they soon will in the rest of the country too. Is the UK house price crash on the way?

If it looks like a duck, walks like a duck, swims like a duck and quacks like a duck, as the old saying goes, it most probably is a duck. The same principle applies to the present house price crash in London. In the last two months, the average house price in London has fallen 5%. In the context of the massive rises in house prices over the last few years this doesn't sound like much, but consider this: if prices in the capital keep falling at this rate, they will have fallen 30% from their peak by this time next year. And that would look rather like a house price crash. There aren't many who think this will happen (there are still armies of industry spokesmen out there assuring us that residential property is still a good long-term investment, and that prices will, at worst, just level off and stay flat), but I do think it is time to take the risk seriously.

There's no levelling off at the top end

One of the things that the proponents of the "level off" theory constantly tell us is that, even if prices were to fall, the top end, and particularly the central London top end, won't. But that doesn't seem to be the case. Instead, asking prices in Camden are down 5.9%, Westminster is down 7.1% and in the yuppie heartland of Hammersmith and Fulham, prices have fallen 11.5%, according to online estate agency Rightmove. But it's the Royal Borough of Kensington and Chelsea, London's most expensive borough, that provides the real wake-up call. There, asking prices are down a whopping £96,309 on average. That's 14.1% in just two months. Prices are now 7.3% lower than in September last year. So much for the idea that the top end is immune to the impact of rising interest rates.

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Nor at the low end

Miles Shipside, commercial director of Rightmove, calls the overall market "stalemated", but it's rather worse than that. The fact is his own numbers show that, unlike last summer, this summer has seen a significant excess of properties coming onto the market compared to those coming off. Not only that, but the number coming off the market is way down on a year ago too. At the polar opposite end of the scale to top-end London, "prices are weaker for lower value homes", writes Shipside. "Both terraced [houses] and flats have seen prices come off [nationwide] around 3% in two months." This is equivalent to a near 17% annualised drop.

What does a crash look like?

The question to ask ourselves now is, "What does a property crash look like?" The answer first of all is that it doesn't look like a stockmarket crash, at least not at first. Property is illiquid, so everything happens in slow motion. Take Rightmove's price data. This records sellers' asking prices, not the prices they actually sell at. Indeed, Mira Bar-Hillel, writing in the Evening Standard, quotes Russell Jervis of estate agent Haart as saying, "We have been advising asking-price reductions of 7% to 10% due to there being fewer buyers." There are a lot of sellers out there who won't have been able to bring themselves to do that yet.

It looks like a rippling wave

We've written before on these pages about the early signs of serious trouble for property, at least the ones we saw last time there was a crash, including a sharp drop in transaction volumes and sizeable developer discounts. But the last UK crash brought up a couple of other interesting signs as well. In the late 1980s, for example, property prices surged first in London and the southeast before a well-reported "ripple-effect" washed into the north and west. Then, when the crash started (in 1989), it started in London and rippled out to the rest of the country the following year. We're following the same pattern this time: the property market boom clearly started in London and the southeast, yet over the last year the biggest gains have been reported in areas such as the north, Scotland and Wales. If prices follow the same pattern this time - and it is likely they will - we can expect price falls to ripple out again to the currently strong areas

Another sign (and this is my favourite) is non-stop industry denial. Property insiders are predicting a gentle slowdown in the UK's housing market, just as they did in 1989. The Royal Institution of Chartered Surveyors asserts that low rates and low unemployment mean a crash "is not on the horizon". This, despite the fact that unemployment was also at a decade low in 1990. It didn't prevent a crash then. In fact, the crash in property and consequent recession were what then sent the unemployment rate up from a ten-year low of 6.8% in 1990 to more than 10% by 1994. To me, the extent of the denial is as good as confirmation.

There are worse things than a crash

A property crash is not the worst thing that can happen to a property market. Most commentators who were bullish earlier in the year are now content to predict flat prices for several years as wages play catch-up.

However, that would be a recipe for disaster, locking millions into decades of unnecessary poverty. I should know. In 1988 I had been paying £35 a week rent, which allowed me to save enough for a deposit on a £100,000 flat just near a horrible no-go area off the Portobello Road in London. In 1994 I sold it for £99,000, which made me quite a canny property investor by the standards of the day.

However, because I'd bought so close to the top, the mortgage, the rate on which averaged over 10%, ate up so much of my post-tax income that I considered declaring bankruptcy in 1991. My real loss wasn't the £1,000, but the £500 a month more I paid in mortgage than I would have paid in rent for five pointless years of home "ownership". My actual loss was nearer £30,000. Millions of home buyers will be forced to endure the same penury unless prices fall to much more affordable levels.

How long does a crash take?

Analysts who do accept that a crash is likely (those with no vested interest in property) predict price falls of anywhere from 15% to 40%, probably kicked off by the wholesale selling of properties by the buy-to-let investors. But how long will it take? Even some bears such as Roger Bootle of Capital Economics expect the fall in property prices to only last a year or so, since they expect recession to lead to interest rate falls by 2005.

However, once property crashes start they are hard to stop, even with rate cuts. The first half of the 1990s saw rates halved, the cuts starting almost as soon as the property crash got under way, yet prices continued to fall. If it takes the rest of this year for sellers to adjust to the new rules and all of next for them to adjust their asking prices down to the clearing level, it will take at least all of 2006-7 to rally enough buyers to sort things out. If a crash really gets under way, don't expect it to end before 2008 - at the earliest.

James Ferguson qualified with an MA (Hons) in economics from Edinburgh University in 1985. For the last 21 years he has had a high-powered career in institutional stock broking, specialising in equities, working for Nomura, Robert Fleming, SBC Warburg, Dresdner Kleinwort Wasserstein and Mitsubishi Securities.