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House price affordability is slowly improving (ie, prices are falling)

The latest property market data reveals that UK house prices are falling in real terms. John Stepek looks at what’s behind the change, and what it implies for the future.

A woman looking in the window of an estate agent © Chris Ratcliffe/Bloomberg via Getty Images
The decline in UK house prices been led by the London and the southeast

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House price growth is now flat or as near as makes no difference across the UK.

The latest figures from Nationwide, out this morning, reveal that prices rose by just 0.2% year-on-year in September.

With inflation at around 2%, that means prices are falling in "real" terms (ie, after inflation).

Better yet, with wage growth coming in at above 3.5% in the last few months, it means affordability is improving steadily too.

Let's hope it's not too good to last.

What goes up occasionally comes down

The decline in house prices across the UK has been led by the London and the southeast of England, where prices are now falling year-on-year.

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This makes sense. Prices in London and the southeast recovered most rapidly from the 2008 crash, and have since risen far beyond their 2007 high points. London has also been hit hardest by rules making it more expensive (and more onerous) for overseas buyers to purchase high-end homes as trophies or safety deposit boxes.

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Elsewhere in the UK, prices are still rising, but at a slower pace. Northern Ireland (which is always a bit of an outlier) is showing the fastest growth, with prices are still rising at about 3% a year, but even that's a slowdown from the second quarter.

And in many of these regions it's worth remembering that adjusting for inflation prices have never recovered their 2007 levels in the first place.

So what's going on? If you knew nothing else about the economy, and someone told you that interest rates were at 0.75%, employment was at its highest level in at least 40 years, and inflation was running at 2%, you could be forgiven for guessing that house prices were soaring.

They're not, of course. So what's changed?

Amateur landlords have been ejected from the housing market

How much of this slowdown you want to attribute to Brexit will depend on your politics more than any perception of the facts. The reality is that activity in the housing market hasn't really changed.

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The number of mortgages being written each month to fund new house purchases has remained pretty stable for the past two years. So people are still buying and selling (there's only so long that you can "hang on for Brexit" after all).

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Politics has, however, played at least some role in the great property slowdown. What has happened in the last four years or so is that the political landscape has turned hostile towards the idea of property as a private investment.

If you already own a home, you will have to pay extra stamp duty to buy another one. If you own a home that you rent out, you no longer get tax relief on mortgage interest payments. It's harder to get buy-to-let mortgages than it once was, and they cost more.

On top of that, various regulations around being a landlord have been tightened up considerably. And the government is still tightening these rules eg, the period for which you can claim relief from capital gains tax if you previously lived in a property that you now rent, has been slashed.

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Whatever you think of all this, it has had the effect of levelling the playing field between landlords and first-time buyers.

Overall, the effect of all these rules means that houses are no longer an attractive investment at current prices, because the cost of buying and holding them has been driven higher (even ignoring the political risk, which we'll get to in a moment).

The key thing to understand about house prices is that they are not primarily related to physical supply, they are much more affected by the supply of credit. Stripping out any nuance, once someone has found a house that they want to live in, they will bid what they can afford to pay for that house.

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So if you have £800 a month to spend on shelter, then the price you will pay for that house will be whatever mortgage £800 a month will currently get you, plus whatever deposit you can scrape together. This is why house prices rise when interest rates fall because £800 a month will buy you a bigger mortgage.

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Before all these rule changes, tax relief and relaxed lending criteria meant that, in effect, a landlord with £800 a month to spend would be able to buy a bigger mortgage loan than a first-time buyer with £800 a month.

But with the changes kicking in, this is no longer the case. So, in effect, you've knocked the top layer of "bidders on houses" out of the market. So it's no wonder that prices are declining, even if that was an end to the changes the maximum price that can be paid has fallen.

And of course, it's not an end to the changes. All of these things happened under a Conservative government. Landlords became public enemy number one while George Osborne was chancellor. How do you think John McDonnell might feel about them?

(I mean, you don't have to imagine he's already arguing for a "right to buy" for private tenants, as we discussed here).

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So right now, any landlords with any sense of self-preservation and any capital gains to lock in are selling up or thinking about it (or incorporating, which is a whole other kettle of fish, and which implies a level of scale and professionalism that will only include a minority of the "buy-to-let" boomers).

How far will house prices fall?

What does this imply for house prices in the future?

If this is primarily about landlords being knocked out of the market, and affordability adjusting accordingly (to what home buyers can pay, rather than pre-Osborne era landlords) then you'd expect an adjustment rather than a crash or a sharp decline.

As I've said many times before, that would be healthy. Improving affordability would leave people feeling less frustrated, while mild declines in prices wouldn't hurt bank balance sheets to a dangerous extent.

A big jump in interest rates or unemployment would be a different matter. That doesn't seem to be on the cards as yet. So, fingers crossed, we can keep going with the gentle decline.

That could still mean a fair old fall the house-price-to-earnings ratio, even by Nationwide's figures, which are arguably generous, is still well above its long-run average.

But if wage inflation keeps going, we could get there faster than we think.

Meanwhile, if you are still a buy-to-let landlord, I do think it's worth having a good hard think about what to do with your investment. At the very least, consider how dependent your finances are on the sector, and have an exit plan in place.

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