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2011 the year that UK house prices finally fall

Posted on 28 December 2010 with 19 comments from readers

Prices that defy the forces of economic gravity do not stay high forever. UK house prices must fall into this category as outrageously high if judged by historic income multiples and the bleak economic outlook.

Why have they stayed so high? The first rumbles of the financial crisis came in August 2007, more than three years ago. UK house prices dropped 10-20 per cent and then rallied back almost to their previous peak. For chartists that is a classic double-top and usually forewarns of a big correction back to price levels seen much earlier in the cycle.

Mortgage costs low

What has kept UK house prices up is obvious enough: the super-low mortgage rates of the financial crisis. But this is also the market’s most obvious achilles heel. For mortgage rates are set by global bond markets and these markets respond to debt levels and inflation.

Now the UK’s inflation rate is above three per cent while official interest rates are nearer to zero. Depositors are therefore losing money, not something that is likely to keep them satisfied for long. There is also the worry that mounting debts may never be repaid, and after Spain the UK has the highest debt-to-GDP ratio in the entire world.

That interest rates are going up is clear and this looks to be a global phenomenon for the year ahead. The Chinese raised their rates 0.25 per cent on Christmas Day hoping to bury this bad news in the seasonal merriment. Higher mortgage rates are not going to help new mortgage lending to improve from present record low levels.

Then you have to consider the demand side of the UK housing equation. VAT goes up on January 4th, a tax on consumption. There are massive public sector job cuts in progress. This is not an economic environment in which to buy an overpriced house. Renting is much more attractive because of the capital risk of buying, quite apart from the historically high deposit requirements.

Tipping point

Eventually such a market has to tip over. Somebody, somewhere will have to sell for whatever they can get. A rise in repossessions due to rising unemployment will also put houses onto the market at a discount.

New Year’s predictions of a two to five per cent fall in house prices in 2011 look wide of the mark. They just do not take into account likely further shocks to the UK economy vis-a-vis higher interest rates and unemployment, and not to do so makes them worthless and obviously wrong.

House prices tend to crash slowly and a 10-20 per cent annual correction over two to three years is only what is needed to bring prices back into their long-term relationship with income multiples. This has happened already in places as far flung as Florida and Dubai, and it will happen in the UK too.

Posted on 28 December 2010 Categories: Global Economics

19 Comments posted by readers:

Comment by Jeff - 29 December 2010

Well I guess it will hinge on how much longer the housing market bailout measures remain tenable. Let’s explore these:

1) Negative real interest rates (0.5% with RPI touching 5%)

So far no real pressure for rate rises – just a handfull of toothless savers moaning. BoE basically said CPI will hit 4% and rates will remain at 0.5% next year.

2) The Government pays your mortgage when you can’t.

ConLibs have cut the rate paid (New Labour were happily paying off people’s capital with taxpayers money!) However, I can’t see it being withdrawn any time soon as repo’s are now no longer politically correct.

3) The builder’s cartel, i.e. Barratts, Taylor Wimpy etc. These people are basically land price speculators who rack up vast debts buying up ‘land banks’. A house price crash would have bankrupted them, and their lenders, HMG supported banks, would have made (even more) huge losses. Not surprisingly these gamblers, who bet wrong, are being bailed out. The supply of new homes therefore is being carefully controlled.

4) Housing Benefit (The Buy to Let investor’s best friend). Despite the proposed crack down the LHA rates are still being increased in accordance with new Labour’s requirements that scroungers must be able to rent properties well beyond the reach of working families. Under acute vested interest attack, the proposals have been postponed and the plans will no doubt be scrapped before long. Landlords need not fret, the £13bn per anum will continue to flow into their pockets.

5) Tax. UK tax laws are designed to make speculation on house price rises as profitable as possible. Houses cost next to nothing to sit on, can be let then sold at short notice…there has been a small increase to CGT, but who pays that anyway on residential sales? Not your MP that’s for sure! The bottom line is people are keeping unneeded properties off the market because they don’t see a more attractive investment.

So assuming no major changes in the above, don’t expect any significant falls in average UK house prices.

Ed Note: Major changes are coming, housing moves in a cycle like all markets. Whenever somebody says ‘this time is different’ you are reminded that things never are.

Comment by philcu - 30 December 2010

Jeff’s points above (esp. 3 & 4) remind me of Bill Bonner’s visceral parable of zombies feasting on Western capitalism and gradually killing it.

As Jeff says, the UK property market is being propped up by government bailout and borrowing. The idea is to keep nominal values stable for those not forced to sell, until inflation and/or recovery revives the market. Kick that can down the road.

Comment by Steven Shaw - 31 December 2010

Hmmm, a 10-20% fall over 2-3 years might be what is “needed”. i.e. a soft landing. Can’t imagine that’s how it’ll play out though. If interest rates spike along with VAT returning to normal and mass redundancies in the public sector, I just don’t see a soft landing – despite all the incentives that Jeff mentions.

Wages/Income has certainly gone down in the UK. I’m a freelance IT contractor. I was in the UK between 2005 and 2007. It was reasonably easy to find a contract for 400gbp/day up and down the UK. I’ve been keeping my eye on the market and it seems that contract work it scarcer and paying in the region of 250-350gbp.

It is stunning how well the UK house prices have held up though. I’m only getting 0.5% on my savings there. Anyone got a mortgage? What’s the current mortgage rate?

Comment by CV Genie - 07 January 2011

I’m surprised just as much as the rest of us. I believe as soon as we get an interest rate rise they’ll be a considerable crash – in the region of 20-30%…. sellers are going to get really scared. Also with the government job cuts coming there’s sure to be further pressure and those who don’t have the skills or a good CV with a business specific achievements will struggle …

Comment by Jonny - 17 January 2011

From what we have seen so far it would be fair to conclude that any interest rate rise instigated by the MPC is likely to be postponed for as long as possible. The reason being – as mentioned by others above – is to keep nominal house prices up as long as possible, but also to improve the financial position of the government (increase real revenues and reduce real debts). Its seen as a short term win-win for the government and UK home owners.

With government finances becoming increasingly stretched and its financial position worsening, additional rounds of QE are likely. However this would lead to a rise in interest rates due to gilt yields increasing and seeing as rates are still at all time lows this would obviously lead to a nominal fall in house prices. As this is not palatable for the government or home owners, the government will attempt to prevent this somehow (eg getting bailed out financial institutions to increase their purchases of gilts to avoid a rise in yield).

If the government can orchestrate such a scheme and continue to sell gilts despite additional rounds of QE then nominal house prices will be upheld (and may increase), and also government liabilities will be eroded. This is a much more palatable outcome for the government. However the effect would be a drop in real house prices as the GBP devalues.

With an all pervading mindset of ‘kick the can down the road’ I suspect the government will do everything in its power to avoid jeopardizing its position and that of UK homeowners so I think inflation will accelerate and nominal house prices will be upheld as long as possible (assisted by government tinkering), whereas real house prices will fall along with a declining GBP.

Comment by Daughter of Hecuba - 24 January 2011

Although I agree with some of your sentiments, Jonny, I have to ultimately disagree with your conclusions on low interest rates. The fall in value of the GBP that this would drive in the medium term would be catastrophic for the British economy: inflation would go through the roof as we are a huge net importer and we would be in severe danger of being locked into a high inflation/ no growth spiral. Ultimately the government will have to act (to increase interest rates and hence the GBP). This may* have a negative effect on growth but it is ultimately better to have low/ no growth than stagflation.

*Increasing interst rates will increase the spending power of savers which will compensate, at least to some extent for the loss of spending power of borowers – the net balance of effects may well be fairly neutral.

Comment by Jonny - 25 January 2011

D of H:

Thanks for the reply. I am not saying stagflation is the best solution rather I am trying to be pragmatic and look at what the most likely outcome will be.

I agree with you that increasing rates is the way to go but it is naive to think the government operates in the nation’s interests; it pursues it’s own interests and those of its backers. I believe our leaders are simply not able to enact policies which would benefit the country in the medium-term as the result would be political suicide. So they limp on, dealing with problems as they occur without any coherent strategy.

Whilst you are correct that raising interest rates is what is needed, the politicians and banks are in bed more now than ever before (or at least more visibly). A property price crash would decimate the already stretched bank balance sheets, it would make the nation feel poorer and consumer spending would halt; it would also stoke further resentment at the government who is already being chastised for spending cuts.

I will concede that rates could go up, but if they do it will be a token gesture intended to appease those calling for rate raises and will likely be done far too slowly to make any real difference (this will allow them to give the impression that at they tried but feared quicker/larger rate rises would hurt the economy)

“Increasing interst rates will increase the spending power of savers which will compensate, at least to some extent for the loss of spending power of borowers – the net balance of effects may well be fairly neutral.”

This is true but do not forget over the last few years we have shifted from a private credit bubble to a public credit bubble; the government’s solvency is now in question and – like a desperate person facing financial ruin – it will do everything it can to prevent it (NB: allowing inflation to run at just 5% for 5 years reduces the government’s real debt by over 23%).

In such an atmosphere can we really believe the government will demonstrate integrity? Sadly I think not. Excuses will be made for additional money printing; Government pundits will continue to justify why rates should not be raised (or raised by negligible amounts) despite inflation increasing. If the government cared for the nation why did they withdraw NS&I index linked saving certificates in July last year? I suspect they know what is coming: inflation and lots of it!

Comment by Jonny - 25 January 2011

The other thing the government has done and will continue to do is obfuscate/manipulate inflation statistics.

When talking about inflation they will jump between CPI and RPI when it suits them and also alter values or simply change completely goods and services that compose the basket of goods that measures inflation.

Finally I would add that any growth in the UK economy over the last 10-15 years has been illusory as no real wealth has been created. Increases in GDP are largely the result of consumption, asset price inflation and government spending all funded by debt.

This is the problem with using GDP as a measure of a nation’s wealth; it is in fact a measure of economic activity and does not take into account growth funded by debt which in reality is not growth at all but the foregoing of future wealth as that debt has to be paid back with interest.

Comment by Duncan - 25 January 2011

The UK house market has one unique feature that was touched on earlier – there is a finite shortage of houses.

Overpriced land, punitive planning controls ( why should anyone with land sell it and be ripped off by builders, HMRC and local govt) and more people living alone mean that demand has gone up while housebuilding has slumped.

So unlike Ireland, the US etc. there is still a major disparity between supply and demand that will slow the reduction in prices. Most Brits will sit tight in their ‘castles’!

Comment by Steven Shaw - 25 January 2011

What is a finite shortage?

Ed Note: I think this just means ‘constant shortage’. However, tight supply has always been a feature of UK housing, even when prices were much lower, so I am not sure how a finite shortage has any influence on pricing. It is a financial issue, can people afford to buy and/or stay in their homes at current prices? When they cannot the prices will fall.

Comment by jeff - 25 January 2011

The poor GDP figures have just assured 0.5% IRs for the rest of 2011. Good new for house prices.

BoE will keep IRs near zero until we see robust house price inflation.

Ed Note: bond markets set interest rates not the BoE and bond markets do not like inflation.

Comment by Jonny - 26 January 2011

I agree the problem is about affordability and not supply constraints. When mortgage rates return to the long term mean of 3.5 times salary instead of the current 6 or so housing will be more affordable.

However there are too many vested interests at stake and so for the foreseeable future I believe the government will allow inflation to take hold to maintain nominal house prices and devalue the GBP; this will reduce real debts at the expense of savers and (should) make the UK more competitive (although all currencies are being devalued in a race to the bottom). From the government’s perspective it’s the best option (of a bad bunch) and therefore in my view the most likely outcome.

The UK government has bailed out a number of banks and those banks are buying government debt which counts towards the tighter capital reserve ratios imposed in the wake of the financial crisis. The bond market cannot be relied upon to set interest rates. I agree with Jeff, for now the BoE is in charge.

Readers may be interested in the following thought provoking article:
http://www.howitends.co.uk/the-housing-market.php

Comment by jeff - 26 January 2011

As Jonny alludes to, the Gilt market looks like a massive scam orchestrated by the banks and the Government. UK banks are maintaining their capital reserves by buying Government Debt. Gilts at 2-3% look far more attractive than cash on deposit at the BoE at 0.5% and probably explains a good part of their recent ‘profits’. I guess the hope is they will never have to liquidate the IOUs on mass as their will be no buyers.

From my perspective the plan appears to be for persistent inflation/devaluation with fall guys being savers and those who are unable to achieve income rises in line with prices.

Comment by geoff - 08 March 2011

I own a house in south wales, and just before the crash was valued at 115k, on speaking to my morgage lender last month i was advised the propertly was only worth 93k, thats at 22k fall, in 2 1/2 years, and in fact is falling at about the amount of morgage i pay each month, so 10/20 fall is the real deal, and for looks set to fall further.

Comment by Steven Shaw - 09 March 2011

Hi Geoff,

2 1/2 years ago only puts the start of the housing bust at mid-to-late 2008. By all accounts I’m come across, the UK housing bust started about mid 2007. You might find that your house lost a bit of value prior to your 115k figure… That’s a pretty inexpensive house though compared to some and you situation may be better than renting. How does it compare with renting in your area?

Does anyone think UK base rate may be due for a rise off it’s bottom of 0.5%?

Variable mortgage rates seem to be about 4.5%. Is a 4% gap normal? It seems high.

Cheers,
Steve.

Comment by Geoff - 09 March 2011

Hi Steve
I have looked at the rental market, but i would only get about 2/3 sof my mortgage, then i would need to find somthing else.
As for the interest rate going up, its really got to in the end just hope it’s not for a while yet.
mines higher 5.45%, how can they justifiy it, we have no choice but to pay as changing mortgage companys now is not even an option. and i don’t think it will change any time soon.

Geoff

Comment by Steven Shaw - 11 March 2011

Geoff, I’m not sure that I understand what you’re saying. If you sold today, do you think you’d only get 2/3 of what you owe on your mortgage? The bank said you house is currently worth 93k… That’d mean you owe almost 140k on your mortgage… but your evaluation was only 115k a couple of years ago. You didn’t go for one of Northern Rock’s 125% LVR loans, did you?

Comment by geoff - 11 March 2011

Steve
No i was commenting on the rental market, my morgage is 670 month but would only get 400/450 month if i rented it out.
i do have some equity but only about 5k, but should be nearer 20k, apparently part of the problem, is people selling under market value just to get rid, as they can no longer afford to keep there homes.
Just before the crash i did look at a tracker morgage, but didn’t like the £1300 fee which seemed a lot at the time…….how i wish i had taken it, at 1% above base.
Geoff

Comment by Steven Shaw - 12 March 2011

Thanks for clearing that up Geoff. It’s a tough situation. You’re paying £220/month more than you would be if you were renting for the privilege of one day owning your property. It doesn’t seem to be enough of a saving to simply sell up and rent for a few years. I sympathise with your view that some sellers are selling “under market” but my view is that they are simply meeting the market and that the market is softening.

It’s amazing that the BoE kept rates on hold with the CPI at 4% and the RPI at 5.1%. Though I think it’s probably true that the “recovery” cannot bear a rate increase. I have savings in the UK that I saved up while working there from early 2005 to late 2007. While I earned that money, each GBP was worth about $2.40AUD. Now each GBP is only worth $1.60AUD – a lost of about 35%. In my mind, those savings are virtually written off – they provide no income to speak of. However, I am expecting a fall in the AUD sometime sooner or later and perhaps I’ll finally bring those savings home.

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