Housing market faces years of gloom

Allister Heath
IT may not feel that way in some parts of Greater London but the housing market remains stuck in the doldrums. This is not surprising: the great housing bubble of the noughties hasn’t finished deflating yet. The readjustment process is continuing, with prices falling in real terms – and there is still a decent way to go, as a thought-provoking report from Citigroup demonstrates.

Even though cash prices are down 18 per cent from their August 2007 peak, according to the Halifax, the cost of residential property compared to incomes remains higher than it used to be. The average house now costs around 4.45 times average annual incomes, well down from the peak (5.81 times in July 2007) but still above the post-1983 average of 4.0 times. One of the most powerful rules of statistics is “reversion to the mean” – over time, average relationships tend to reassert themselves, often in a most dispiriting manner. Of course, it could theoretically be different this time – the fact that so few new homes are being built exerts a large upwards effect on prices. And very expensive homes operate in a market of their own, of course. But after the previous crash (in the early 1990s) prices fell to 3.1 times earnings. So the fact that we remain so much above the long-run average suggests prices have further to fall.

It is true that in cash terms the drop in prices in this cycle exceeds that in the early 1990s (nominal prices then fell just 10 per cent across the Halifax and Nationwide indices). But once consumer price inflation is accounted for, the 25 per cent real terms house price drop so far this time around remains below the 30 per cent slump suffered after the 1973 and 1989 highs. Given that the most recent bubble was much more extreme and that interest rates remain so low (and will soon rise), it is fair to expect the present correction to be more pronounced in real terms than the previous one. That suggests that real <a href="http://www.cityam.com/house-prices";>house prices</a> could fall another 10 per cent or so.

There is, of course, a different way to measure affordability, and that is to look only at how much a mortgage costs. On that measure, buying a property is still remarkably cheap -- interest payments are just 12.7 per cent of incomes for first time buyers, the lowest since 2003 and less than the 16.2 per cent post-1974 average. But the problem with that measure is that one cannot just pay interest forever: at some point, debt must actually be repaid. Another crucial issue is that the average first-time buyer deposit is now 78 per cent of annual income. This is down from 104 per cent in 2009 but remains well above the long-run norm of 10-30 per cent.

The good news is that credit availability is gradually improving, with the average deposit paid falling to 20 per cent and the number of mortgages on offer increasing. But those such as Michael Saunders of Citigroup who argue that house prices are likely to remain depressed for a long time to come, as they did after peaking in 1973 and 1989, are right. House prices in real terms were still about 20 per cent below their pre-crash peak in 1983 and 1999. The early 1980s recovery, which saw real house prices bounce back and recover fully after just six to seven years, was an exception caused by the deregulation of credit.

It will be a long hard slog, especially as rates rise, to the frustration of existing homeowners – but to the delight of those seeking to break into the market by buying their first property.


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