The ratio of house prices to incomes in the UK is close to the all-time high it reached before the financial crisis. If that ratio mean reverts over the next few years, we are looking at the mother of all price crashes. The scale of potential mean reversion in the house price to income ratio obviously depends on the period chosen to calculate the mean, with estimates varying from a 20 per cent to a 40 per cent correction.
But the counter argument is well known, namely that debt servicing levels remain very affordable. Record low interest rates mean that the cost of an average mortgage is as low as it was back in 2000.
Debt servicing costs will of course change with any normalisation of monetary policy, with particular concerns over the estimated 1m zombie mortgage holders who could slip under water. But if those mortgage holders began slipping under water, any normalisation would likely get stopped in its tracks.
Another argument is that first-time buyer deposits are much too high for a stable market, and that this will determine some form of house price adjustment at the bottom of the ladder. The combination of tighter mortgage lending criteria and house price growth over recent years means that first-time buyer deposits have reached £34,000 across the UK, and a gobsmacking £96,000 in London.
These numbers do look high, until you cross-check them with other first-time buyer numbers. First-time buyer deposits as a proportion of the purchase price have actually fallen in recent years, from 20 per cent in 2013 to 17 per cent last year. First-time buyers are well and truly back in the market, accounting for 49 per cent of all mortgages last year, helped by the Bank of Mum and Dad, and Uncle George’s (Osborne) Help to Buy schemes – and that’s not due to weak transaction levels. UK housing transactions exceeded 1.2m last year, for the third year in a row.
Despite moderate mortgage debt servicing costs, I can’t help worrying about potential mean reversion in the house price to income ratio – largely driven by falling prices, not rising incomes. Yet again, however, there is a counter argument, this time from those who believe in an 18-year residential property price cycle.
For this school of thought the market bottomed after the financial crisis and won’t peak again until the mid 2020s. Eighteen-year cycology deserves attention, but it isn’t a precise rule. My problem with 18-year cycology is what happens to the house price to income ratio? An 18-year cycle peaking in the mid 2020s would surely require house prices to rise by less than incomes, or only a little faster, for most of the period?
One final thought on the London property market. The post-Brexit depreciation in the pound, a potential dollar surge in the US (with a one-off repatriation of profits), and a capital outflow from the Eurozone with any resumption in the euro crisis all have one thing in common. They’re potentially very good for the prime central London market. So maybe the correction in the London market will reverse over the next 12-18 months.