Why the outlook is bleak for the property market

published 26 July 2006

Property prices. Will they rise? Will they fall? Will they stay stagnant? Our roundtable finds out

This month, we asked eight housing experts to give us their views on house prices. Unfortunately, the prognosis is not good...

Merryn Somerset Webb: The data on property prices has been pretty awful recently. Is anyone still bullish on the residential property market?

Miles Shipside: I'm still looking for a gentle rise next year. The market has come to terms with the fact that prices do have to re-adjust before the spring. If people keep looking for silly prices we could well see a soggy market next year, but the estate agents are working hard to make their clients be realistic. That should tempt buyers back in. Obviously, a rate drop would help too.

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MSW: Is that something you'd expect?

Ed Mead: The interest rate is going to drop next year. It is the only tool available to the Government to control house prices. But the problem is that there is noone-size-fits-all way to look at the UK market. The overall indices may have been showing prices rising fast, but the fact of the matter is that for the last 18 months things in London haven't been that easy. It is prices in the rest of the country that have been shooting up. House prices are now starting to level in the rest of the country. But that's not exactly a disaster. There's no reason for prices to collapse.

Bill Bonner: You say that people are cutting prices. By how much in general?

EM: Probably around 10% at the moment in central London. That said, I think that there's still a huge demand. There may be a lull now as people wait for the new year to buy. Whenever the market changes a little, there's always a three-month period when people take stock, but they never want to be out of the market for too long. They don't care whether it's up or down. People want somewhere to live. They don't like renting, and by the way, I've been renting for 20 years. I don't own a property, but most people are completely obsessed with owning property. They aren't going to stay out of the market for very long - particularly given that rates are very low and people aren't borrowing too much. It's pretty sane and sensible out there.

Tim Price: Why do you say people are obsessed with owning property?

EM: Well, it's become part of their investment strategy. People have stopped looking at their house as their home. It's now part of their net worth.

John Calverley: This is why I think we are living through a bubble. One of the characteristics of a bubble is that people start to regard an asset as something to buy because it's always a great long-term investment. That's what's happening in the UK property market. Media interest around the market has reached extreme levels; prices are now at the fringe of affordability. That makes it very difficult, I think, to go up much from here. If things don't go too badly for the economy now, prices may just drop next year, but if anything going wrong with the economy or with interest rates, then we're going to go down a long way.

EM: But don't you think prices have gone up because there's a shortage of property?

JC: No, I don't. Obviously, immigration and various other things suggest prices should be higher than in the past, but there are also reasons why they should be lower. The tax treatment of housing is much less favourable than it used to be. We don't get mortgage interest relief, for example, and stamp duty's higher. It's much less attractive now to buy a house than it was.

Richard Donnell: But what's the option? How many four-bed, family houses can you rent in the country these days? Practically none. Only 5% of our housing supply is for rent. And most of that 5% comes in the form of one- and two-bed flats. This means that most people can't find somewhere to rent. So they can't make a rational choice between buying and renting. They have to buy. The statistics might show that it's cheaper to rent than buy in much of the southeast, but most people with 2.4 kids would find it pretty hard to do.

James Ferguson: I think we all agree that all families in this country aspire to house ownership, and probably to the best, biggest, most southeasterly house they can afford. The real question is at what point can they no longer afford to buy. It isn't what they want, but what they're capable of. When they can't pay any more, the market crashes. That's what caused the crash at the end of the 1980s.

Capital Economics have done a lot of work on affordability. They say if you include mortgage repayments, which you should, and unsecured debt, the debt service burden for the country as a whole is greater than it was at the last peak in 1989/90. Halifax says the opposite, claiming affordability levels are fine; that only 19% of average earnings are spent on housing costs. But they use a house price of £163,000, when we know from the land registry that the average house price is £188,000, They use a loan-to-value figure of 75% (ie, they assume deposits of 25%), which gives them a much lower loan than if they used the real data. As an average income number, they use £35,000, when the average earnings of a male who's employed is £28,830.

On top of this, they don't use a repayment mortgage to do their figures, but an interest only one. So what happens if you use what I consider to be the correct numbers? You get not 19%, but 36%, the same level as the high recorded in 1990.

EM: But given that so much of the nation's debt is secured not unsecured - 75% is secured against property - that doesn't sound panic stations to me.

JF: The idea that something is okay because it is secured against property is a false security. When property prices fall debts don't fall too - they stay the same. So the fact that people are seeing house prices rise and then rushing out to borrow more against their houses is not a good thing.

MSW: Except it has created the consumer spending that has kept the economy going for the last few years.

JC: We haven't even talked about the people who are using housing as a kind of pension. This is a very dangerous trend. I think that over three or five years, during which we'll probably get an economic downturn - they always come - we might find ourselves in trouble.

RD: I'm not saying prices can't fall. But the crashes of the past have been brought on by economic problems, when interest rates shoot up and people can't service their mortgage, and unemployment is high. None of that is happening now.

JC: That is true for now. And if rates and unemployment don't rise next year, I'm with the people who think prices won't fall very much.

RD: And if they do, I'm with the people who think prices will fall a lot.

JF: I think you are all getting this the wrong way around. What do you think caused the recession of the early 1990s? Do you know that unemployment was at a decade-low at the top of the last housing bubble? Unemployment is always low before a crash. House prices go down first, not last. And before housing goes down, what happens? Liquidity plummets. The first sign of a housing crash is a year of transactions diving. Like this one, for instance. Mortgage approvals are down 40% year on year, and houses that were on the market for £800,000 last year now won't sell for £700,000. You haven't seen that fall in the statistics yet, because that house at £700,000 is still not in the data. And it won't be until it sells. Then it will be clear that prices are falling and everything else will follow. Every time housing collapses, within 12 months unemployment goes up by at least 40%. Why? Because suddenly we have fewer house purchases, which means fewer white good sales. Not only that, but any money from mortgage equity withdrawal used to finance consumption disappears completely. All these supports to the economy go

RD: Turnover in London peaked in 1999, and it is peaking now in the northeast and Wales at around 9% of stock. But in London it isn't that it has collapsed. We are being blinded by falling year-on-year and month-on-month changes. But when I look at the mortgage approvals data, I see things coming back to what I'd expect in a normal, sensible market.

EM: But what's the problem if house prices fall a bit? Most people have owned properties for more than three or four years; it's gone up a bit, it's come down a bit. Unless you've bought in the last 12 months, you've not got a problem.

JF: The problem is exactly the same as in the early 1990s. If the momentum changes direction, everyone involved in the debt-fuelled speculation that characterises bubbles gets hit. Much buy-to-let, for example, is speculation.

EM: Everyone said the market was going to go crash when the buy-to-lets came to sell earlier this year. But that didn't happen, did it? They haven't sold and the market hasn't crashed

MSW: Yet. This comes back to what James was saying about houses that don't sell not showing up in the indices. You only have to take a quick stroll around Paddington Basin to see there is trouble in the buy-to-let market. There are scores of one- and two-bed flats for sale. But no transactions. The sellers won't drop their prices enough to get the flats away. But at some point, they'll have to, and then we'll see the panic in the numbers. In my building alone there are at least four flats for sale. When one of them finally sells it will go for £100,000 less than the last one sold, and suddenly the price of flats in my building will be down 25%.

RD: We've done a survey of 4,000 buy-to-let investors, in which we asked them what they intended to do. And most of them have no intention of selling up. They're in for the long term.

MSW: They may think they are, but once they've lost money every month for a while and realise that they won't be making much capital gains either, how many will hang on? There are an awful lot of people who are not covering their mortgage payments with rent. How sustainable is that?

EM: You can blame Gordon Brown for the fact that they haven't sold yet. He's put up stamp duty so much that the cost of buying and selling a property now is prohibitive. If you've got a property of £250,000, it will cost you about 7% of your capital to buy it and sell it. So a lot of people would rather take a small hit every month and not sell.

MSW: Buy-to-letters only need to sell. They certainly don't need to buy again.

JF: Can I make another point about buy-to-let. You don't need people to sell for a market crash. You just need them to stop buying. Buy-to-letters have been buying at the margin and supporting the market for years. First-time buyers just aren't in there any more. What will happen when they're both gone?

TP: There's another issue of interest. Everyone thinks rising prices are a good thing. Why? Warren Buffet once asked: if you are a consumer of hamburgers and the price of beef falls, should you be happy or sad? Happy, surely. Yet we're all talking as if rising prices are great news for everybody and falling prices terrible. There are people who would be grateful for a fall in house prices and people who are grateful when securities prices fall. Everyone myopically focuses on a rising market, as if you're a consumer at a one-off point in history and that's it. But you are not.

JF: Unless you're at the top of the housing tree and you want to trade down, the only way to benefit from rising house prices is to die (because only then would you not need a place to live) - not terribly beneficial. So most of us benefit by house prices going down so that we can get something bigger for less.

TP: Okay, James. You think there will be a crash. But what's the trigger? It strikes me that if you have a weak economy, the last thing that's going to happen is that interest rates go up, so it won't be that.

JF: It's true that a weak economy has a good case for lower interest rates. But what tends to happen is that inflation lags economic growth. The economy grows. So everyone wants a wage rise. The effects come in, not only a good 12 months or more after the peak in the economic growth, but often when the growth has already turned around. You get weakness and inflation at the same time, so you can't cut rates. And economic slowdown hits your currency. When your currency goes down, you import inflation.

TP: I'm not sure about the currency falling. We still have one of the stronger economies in the world. I'd rather buy into the UK than I would into the eurozone economy or the US.

JC: One of the characteristics of a bubble is that it usually happens after many years of good growth, which is exactly what we've had. We've had a 12-year upswing, so people feel very confident. They think the Government and the Bank of England are doing well and that things will stay smooth, but the world doesn't work like that. Economies and markets go in cycles.

JF: The point is that our economy is basically fuelled by housing and the consumption that it encourages. But that's coming to an end. Look at what's happening in the run-up to Christmas. The retailers are being forced into doing massive sales well ahead of Christmas.

MSW: Things won't get any better. Everyone takes out these two-, three-year fixes on their mortgages these days. But those taken out when rates were low are now running out. They have to be refixed at much higher levels - 30% plus higher - and that will hit consumption too. There are also hordes of people who have their rates adjusted just once a year - usually in January - so that's going to hit too.

EM: In percentage terms, when does a fall turn into a crash?

JF: At the margin, properties plummet - you're going to see 50%-plus drops. But not in smart central areas. The damage will start in London, but it will never be as bad here as it will be out in the distant areas that have had the most recent and very sharp rises.

Adrian Ash: The other thing to bear in mind is that after house prices start to come off, it's very difficult for policymakers to cut interest rates enough to make a difference. From 1990-1996, interest rates went down every year. And so did house prices. At least, house prices relative to earnings in real terms. In real terms, they were down just about 40%.

MSW: If you look at the 1970s crash in real terms, you'll see it took the market 13 years after the peak in 1974 to get back to the same levels (in 1987). Then only two years later it peaked out again. Now we're 12 years on from the last crash.

RD: Ed, you're just perfectly positioned in your rental property.

JC: We haven't really talked about the possibility of what I'd call a genuine soft landing - a fall in house prices of maybe 15% or so over several years, so that earnings rise and the house-price-to-earnings ratio comes back to reasonable levels. The pound falls a bit at the same time so the economy gets rebalanced abit more to manufacturing and industry, and so on. Inflation doesn't pick up too much (it's below target now). This is still not very good for anyone who has bought housing, because it means they may have to wait seven to ten years toget back to today's level (prices fall 15%, stay there for a while, and gradually come up again). But it's not too bad for the economy. I don't give it a great chance of happening, because I think markets tend not to work like that. But it is possible, and I think that's what the Bank of England would like.