The Curious Incident of the Dog in the Night-Time...or of the sales that aren't there

Why should the baffled British property investor look to Australia for clues? Elementary, says James Ferguson

Sherlock Holmes: "The curious incident of the dog in the night-time.Inspector Gregory: "The dog did nothing in the night time.Holmes: "That was the curious incident."

I was sharing a beer with an Australian friend of mine last weekend, when he remarked that a great friend of his, who worked for Jones Lang LaSalle in Sydney, had told him that while you don't see it in the statistics yet, theprices of the houses they're managing to shift are down 20% on last year. Even worse, he said, transaction volumes have halved: sometimes less than half of the properties at auction are making their reserve prices. Overall, he said, houses just aren't selling.

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The Australian housing market is important to us, because it is one of the few (if not the only) housing markets in the world that could arguably be said to be a stage ahead of our own. At the moment, those of us who think that property prices are taking a real tumble are still in the minority. According to Nationwide numbers, price growth is just slowing it is, they say, now at around 2.6%. The industry pundits don't see prices falling much either, but rather levelling off into a slow growth period. But I think their confidence is based on looking at the wrong numbers.

The statistics we have right now are all based on properties that actually sell, not the huge quantity, perhaps even the majority, that just don't sell. As Sherlock Holmes noted, sometimes it's the things that don't happen that are more important than the things that do. In the case of house sales, it's the transactions that aren't taking place that are more important than the ones that do. Until potential house sales can be turned into actual house sales, we are nowhere near being able to see what is really happening in this downturn. Ross Clark in The Sunday Telegraph reports on two other middle-class families, unable to sell even after knocking £75,000 and £70,000 respectively off the price. In one case, the cut was equivalent to 18% of the original asking price. How much more will have to come off before it finally sells?

All this must be a genuine worry for developers in London's Docklands, who are reportedly sitting on £80m worth of new but unsold flats, according to Mira Bar-Hillel in the Evening Standard. The paper counted 263 unsold flats at just three high-rise locations, with another 127 flats, that were initially sold to Hong Kong investors, also on their way back to the market. One resident has already lowered the price of their flat by £180,000, or 27%, yet still there have been no offers.

But the vast majority of transactions that aren't happening at the moment are ones where the seller can't or won't bring themselves to lower the price down to the buyer's level. This means that the current statistics on house prices are not a true reflection of the situation, but rather a Panglossian, best-possible take on the situation. None of the properties mentioned above, for instance, are yet included in the statistics, because none has sold. A collapse of activity is a classic feature of the first stage of any downturn. Only once sellers come to realise that not only are they just not going to sell unless they lower their prices to the buyers' level, but that the corollary is that the sellers of the property they are planning to move to will also have to sell for a lower price, can transactions start to pick up again. The next problem on the immediate horizon, however, is the dreaded "chain". Because not every seller will submit to the reality of their situation at the same pace, many transactions that could otherwise have happened will be held up by someone further up or down the chain who still doesn't get it and won't budge. Selling your house even after you've finally found a buyer and agreed the price may still take months to complete, or even fail, as links in the chain find they have to pull out.

This is why first-time buyers are so important. If they can be tempted back into the market, unencumbered as they are by having their own property to sell, transaction volumes can start to rise again. Unfortunately, as they have built-up property equity and are possibly quite comfortable where they are renting, it may prove no easy task to attract first-time buyers back into a market that no longer offers guaranteed tax-free capital gains.

It should also be remembered that this seizing up of property market activity is also a classic harbinger of any property crash. While there are still many (almost all of whom are industry insiders with vested interests) who would have you believe that property prices won't, indeed can't, come off, the truth of the matter is that all markets' main function is what is called "price discovery". If the market seizes up and volumes collapse, then it is because the prices are too high. Not until prices have fallen sufficiently to reinvigorate the market and bring back the volume, can we say houses are back at the right price'.

Worryingly, despite the fact that Sydney's house prices may already be down 20%, there's little sign of activity being stimulated in the market. I'm not sure that a 20% fall in prices would turn the UK market around either. With the average house price in the UK now £159,000, according to Nationwide, a 20% drop would bring the price down to about £127,000, still 6.5 times after-tax wages.

Just because a big hike in rates triggered the last house price crash, it doesn't mean we won't have a crash this time unless rates rise. It just means it will be more drawn out and painful. Japan's residential land prices, for example, have been falling now for over 13 years and are more than 50% down from the 1991 peak. Official interest rates have also been falling or at zero for all that time. I'm not suggesting that we face anything like such a disaster, but to expect prices to just level off at the highs is just unrealistically optimistic and unsupported by any historical precedent. Perhaps the real-estate industry insiders should be calling for higher rates and encouraging much lower property prices so that the system can clear and we can start afresh?

Somehow, I just can't see them accepting the pain.