Outside prime London, house prices are falling back to earth

Allister Heath
IT is one of the most important economic stories of the past few years and yet the one that is least talked about. <a href="/house-prices">House prices</a> in virtually all parts of the country excepting prime London have collapsed. It’s hard to believe if you live or aspire to live in Kensington, Richmond or another prosperous location, but it’s true – and it’s impossible to understand the overall economy, as opposed to the London bubble, and British politics without getting to grips with these statistics.

The average home in Britain sold for £163,910 in the third quarter, according to Nationwide. That is 11 per cent below the all time high reached at the height of the boom, when the average home was changing hands for £184,131 in the third quarter of 2007. But these figures are in nominal terms. Since then, inflation has substantially eroded the purchasing power of the pound.

The inflation-adjusted figures reveal that the peak to trough real terms decline has now reached around 24.2 per cent. Average house prices are back in real terms to levels last seen in the first quarter of 2003. In other words, all of the gains incurred over the past nine years have been completely wiped out. For most people in Britain, housing has been a poor investment over the past decade.

The figures provided by Halifax are even more extreme. These suggest that the real terms slump in average UK house prices has now reached a remarkable 33 per cent (and 19 per cent in nominal terms). Andrew Lilico of Europe Economics calculates that the real-terms peak-to-trough collapse in the 1990s was 33.9 per cent, so that could easily be surpassed next month.

The Nationwide figures imply that house prices remain at least 20 per cent too high compared to earnings, when using long-run estimates of the price to earnings ratio. One reason for this is that real wages have been falling sharply. But only half of the over-valuation in the UK housing market has been eradicated; so unless nominal prices fall significantly it will probably take another five years for consumer price inflation to bring the market back into synch.

Violent, lengthy booms and busts in the housing market mean that house prices can end up stagnating over long periods of time in real terms. In today’s money, an average house cost £81,708 in the first quarter of 1975, according to Nationwide; it was at virtually the same level – £82,469 – by the fourth quarter of 1995, 20 years later, at the trough of the previous house price bust and after huge ups and downs. Housing during that period was merely a hedge for inflation, nothing more. Timing is everything, and many made a fortune buying low and selling high.

There are, of course, massive regional variations. Northern Irish prices are down 53 per cent in nominal terms compared with 2007 levels. Southern England has seen prices hold up better, in particular London (down two per cent from peak, with some areas at record highs thanks to inflows of foreign cash) and the Outer Metropolitan area. The capital’s price to earnings ratio is at a horrendously unaffordable 7.4 times.

Given how over-valued the London market is, and its dependence on a troubled City and declining bonuses, as well as on potentially fickle foreign cash, a severe readjustment at some stage is a strong possibility, despite supply shortages. London property owners should resist succumbing to delusion. It is also dangerous for the government to encourage first time buyers to jump into the market when prices are falling in much of the country. And at some point, the Bank of England will hike interest rates – and then all bets will be off.

Follow me on Twitter: @allisterheath