Housing market is looking healthier

Allister Heath
THE long upwards run for house prices has ground to a halt. The recent history of UK house prices has confounded many commentators: values plunged when the credit crunch hit, albeit not as much as in the US, then regained over half of their losses over the past year. The present return to stagnation makes more sense: property remains expensive on price to earnings valuation measures and the last thing anybody needs is another property bubble, followed by another financial crisis.

So even home owners and property investors should breathe a sigh of relief on the news that the Land Registry – the most comprehensive measure – has reported that house prices in England and Wales fell by 0.2 per cent month-on-month in May. This followed a modest increase of 0.2 per cent in April and a drop of 0.1 per cent in March – in other words, the market is going nowhere. The year-on-year increase in house prices eased back to 8.2 per cent in May from 8.5 per cent in April.

Over time, house prices tend to rise by roughly the same rate as nominal GDP – around 6.5 per cent this year. We may well end up at that rate of growth for 2010 as a whole, which would indicate a return to some sort of rationality, albeit from an excessively high price base.

Another way to look at all of these numbers is to say that property is a good way to enjoy the benefits of economic growth while hedging for inflation. The retail price index, a broader measure of inflation than the official consumer price index, is up by 5.1 per cent over the past year; this is beginning to have a substantial effect on those who hold cash or gilts. As investors understand this, they will buy property and sell cash.

There is more good news for house prices. Primary residences do not incur capital gains tax. The hike in CGT to 28 per cent for top earners (and the failure to reintroduce indexation for inflation) has made equities, buy-to-let properties and other investments less attractive, as these are taxable – but the rise has increased the incentive for people to buy even larger primary homes. It makes more sense to spend £150,000 on redoing or expanding one’s home than to purchase an investment property.

Buying property in and around London is partly a bet on the future health of the UK economy and of the financial and business services industry. Deleveraging, the bank tax and the US banking reforms will all cramp employment and earnings growth. However, real nasties, such as truly crippling tax hikes on incomes and profits or a Tobin tax, have been avoided. Public spending will be squeezed across the UK but London and the South East, the least socialised regions, will suffer the least from this retrenchment and have the most to gain from increased growth in emerging markets. Many global investors have been reassured by the coalition’s election and especially George Osborne’s Budget, which was better than expected on the deficit and not as bad as feared on competitiveness-destroying tax hikes. The City and Canary Wharf are unlikely to become a desert of empty offices any time soon, and Russian and Middle Eastern demand for Mayfair assets is unlikely to dry up.

On balance, house prices are still over-valued. But as long as prices remain stable for the next year or so, the market will soon begin to look much healthier for investors.