Cover of MoneyWeek magazine issue no 840, Friday 14 April 2017

House prices will plunge as credit dries up

14 April 2017 / Issue 840

A property crash always unfolds in similar ways: credit runs dry, a priced-out majority stymies demand, confidence falters. Sound familiar? Then prepare for the bear, says Jonathan Compton. Read this week’s cover story here.

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Excerpt

John StepekEDITOR'S LETTER

John Stepek

This week we return to one of our readers’ favourite topics – UK house prices. Regular contributor Jonathan Compton looks at the state of the British residential property market and concludes that we’re heading for trouble – see our cover story to find out why.

There’s a reason why house prices are such a perennial topic of conversation in Britain and a regular fixture on these pages – it’s because the market seems to be in a near-permanent state of overexcitement. Prices corrected drastically after the 2008 financial crisis, but in most parts of the country they have returned to pre-crash levels, and in London and the southeast they have long since surpassed them. House-price-to-average-income ratios across the UK are again at or near record levels, while the plight of first-time buyers is noted by every politician with a policy to sell.

It’s true that price growth has slowed somewhat this year. Figures from Nationwide and Halifax show house prices flatlining over the past couple of months, with annualised growth slipping to around 4% – not much higher than inflation, particularly if you use the old retail prices index measure of 3.1%. However, with wage increases still lagging behind at 2.3% annual growth, it’s going to take a long time to inflate ourselves back to affordability at current rates.

Why do we keep finding ourselves in this situation? Debates have been raging about the causes of Britain’s housing problem and the potential solutions for many years. Some say that it’s about physical supply and demand – Britain just needs to build a lot more houses. Others (us included) argue that the real problem is the supply of credit. The quantity of houses doesn’t matter – as long as buyers can borrow increasingly vast amounts of money to buy them, then they will just continue to chase prices higher.

Geoffrey Meen, Alexander Mihailov and Yehui Wang, economists at the University of Reading, agree that simply building more houses can’t fix things. 
In a recent paper, they conclude that there is no feasible rate of physical construction that would “stabilise the price-to-income ratio”. The real problem, in effect, is risk appetite. As long as buyers reckon that property represents a good bet compared to other assets (which an environment of low interest rates encourages), they’ll keep on buying.

The good news for those waiting to get on the property ladder, say the Reading team, is that even without added supply, price-to-income ratios can’t keep rising forever, and so are likely to stabilise. The bad news for everyone else is that this could well “take the form of an undesirable market collapse”. No wonder Jonathan is desperate to find a way to “short” UK house prices.