House prices in the UK (and many other parts of the world) are soaring, squeezing affordability yet further. Rising inflation looks like the most obvious candidate to prick this bubble.
House prices in the UK rose by 10.9% in the year to May.
That’s the most rapid growth seen in almost seven years, according to Nationwide.
The average house price hit a fresh record of £242,832 (precisely).
It looks as if an already expensive housing market is now moving uncomfortably close to “bubble” territory…
Here’s why house prices keep going up
There are lots of reasons why housing market activity is going into overdrive in the UK right now. Monetary policy is loose, and more importantly, credit is flowing freely to the housing market as mortgage lenders compete for business.
People – especially in wealthier demographics – have saved some money during lockdown, so they have more money to bid up house prices (or spend on extensions and renovations and the rest of it).
And people are also moving around a bit more widely than they have before. You have a sizeable group of people moving from very expensive areas to areas where prices have historically been cheaper due to “the commuting discount”. The commuting discount has shrunk now and meanwhile you have an influx of buyers who are psychologically anchored to much higher prices.
My hunch – and it is just a hunch – is that this leads to less price sensitivity. If you sell a flat in London for £750,000 and you see you can get a three-bedroom house by the sea for £400,000 in an area that you don’t know that well, you’re unlikely to bargain as hard or quibble as much as if you were just moving down the road to an equally expensive flat.
None of this is unique to the UK market. We’re seeing similar booms in various markets around the world. (Indeed, the other day, CNBC commentator Kelly Evans made much the same point on the US market right now – “even people who are paying over asking price in Denver… may be pocketing gains if they’re selling in California”).
The one thing that is unique to the UK market is the stamp duty land tax holiday.
At the end of this month, the holiday becomes less generous – the threshold drops from £500k to £250k. Then, from the start of October, the threshold drops back to £125k. (That said, if you’re a first-time buyer you’ll still pay no stamp duty on up to £300k, and a reduced rate up to £500k).
(A quick side-rant while we’re here: I’ve just been looking at the rules for stamp duty again. It’s really quite extraordinary how successive governments have managed to make what was once a relatively simple tax – for anyone with bog-standard, day-to-day needs at least – into a complete morass of “ifs, buts and maybes”. Governments spend lots of time complaining about loopholes, but it would help if they’d stop creating so many of them).
Some commentators believe (or hope) that the end of the stamp duty holiday will put an end to the pace of house price growth. I take the point. Previous stamp duty holidays have tended to bring forward purchases that otherwise would have been made later (or not at all).
However, I wouldn’t bet on it.
The most likely thing to pop this bubble
It would be nice if the end of the stamp duty holiday injected some sobriety into the housing market. But when these things get going, they tend to take on a life of their own. And there are some strong signs – I mean, beyond the frantic levels of activity and the double-digit price gains – that we’re getting into mania territory.
Affordability has been an issue in the UK for decades, but even by UK standards it’s getting sticky. According to Nationwide figures (not the most conservative measure you could use, by any means) the UK house price-to-earnings ratio has a long-run average of just under 4.5.
Now – a caveat. That’s going back to the early 1990s. Like most things – including the Shiller price/earnings ratio in stocks – the low interest rate environment appears to have driven up the sustainable long-term average. So it’s also worth noting that the housing p/e ratio has not been below 4.5 since the early 2000s, and even at the bottom of the last crash (in about 2009), it barely touched the 5 level.
However, even if you’re trying to be very forgiving, the figure really is creeping back up now. It’s back above 6, and it’s only ever been higher during the run-up to the last big bubble, in 2007 (when it reached just below 6.5).
Now you can certainly make the point that interest rates are a lot lower now than they were in 2007. As a result, a given level of earnings will enable you to fund a much larger mortgage than it did back then. And with competition hotting up between mortgage lenders, there’s no reason to expect it to get harder for borrowers soon.
And let’s not forget the good old government. House price booms might be increasingly politically problematic, but house price busts are rarely popular with anyone.
So I keep coming back to the same conclusion: the one thing that pops this – and most other asset bubbles across the globe – is inflation rising to the point where it becomes too difficult for central banks to ignore. And to be clear, by that I mean it reaches a point where they have to do something to contain it and get “ahead of the curve”, rather than just gently raising interest rates to play catch up.
That would involve tightening credit to the point where it would hurt (which is why they won’t do it until they have to).
That might take a while. In the meantime, if you’re a homebuyer fighting off rising panic, my own view is that trying to time the housing market is even more pointless than trying to timing the stock market. On that front, if you’re just buying a house to live in, here’s what really matters.