Why I’m bearish about house prices

Allister Heath
ONE of the big lessons of the recession – and of several previous downturns, including Britain’s crisis in the early 1990s and the secondary banking crisis of the 1970s – is just how important property is to modern economies. Bubbles in housing or commercial property are invariably devastating; they almost always take the economy down with them when they pop. Regrettably, residential property is still overvalued, albeit not by as much as previously; it is therefore good news that prices are currently stagnant, and thus falling again in real terms as a result of consumer price inflation.

The value of privately owned housing more than doubled over the past decade, Halifax research shows. There was a 118 per cent increase from £1,719bn in 1999 to £3,755bn in 2009. During the same period, the retail price index rose 29 per cent. Even accounting for the oft-overlooked but all too real fact that tens of billions of pounds have been spent renovating the property stock, as well as the upkeep costs – say 1.1-5 per cent a year of the house’s value – property owners are sitting on large gains.

The £2 trillion or so increase over the ten year period is equivalent to £33,000 per head of the UK population (and thus £132,000 for a family of four). Even though many people believe these gains don’t really matter because everyone has to live somewhere, in truth higher property prices have had a huge impact. They have helped drive consumer spending (via the extraction of equity) and also investment, as many loans for small businesses rely on collateral in the shape of the owners’ homes.

Since 2007, the value of housing in the UK has declined by 8 per cent in nominal terms, a painful reduction for the 70 per cent or so of the population that owns residential property but a good thing for the long-term stability of the economy given how overvalued property was (and still is). This reflects the reduction in house prices between mid 2007 and early 2009, as well as the strong and partly irrational rebound since then, which has now fortunately come to a halt. It was a false dawn driven by limited supply chased by moderate demand and a realization the world hadn’t ended.

The current stagnation in the market will probably turn into a double-dip for house prices; the rebound after the crash had gone too far and cannot be justified on fundamentals. However, the extent of any further drop is unlikely to be as large as what happened after the onset of the financial crisis. Capital Economics has found at least eight examples of double-dips in real house prices in the international data from the past 40 years. On average, the second leg of those corrections wiped off 12 per cent from real house prices (if inflation is 5 per cent a year, then virtually all of this could happen in two years with stagnant nominal prices).

There are three other reasons to be bearish. The anti-City mood and new taxes and regulations are making London far less appealing for businesses – and not only financial ones. At the peak of the market in 2007, the fall in prices required to restore the house price to earnings ratio to its long-run average was 10 percentage points greater than in the historic cases. And less of the required fall in prices was delivered by the initial crash in 2007-09 than in any previous double-dip in house prices. The next few years aren’t looking great for property owners.