UK house prices 50% overvalued. Bubble is about to burst

Food for thought in todays Guardian...........
Hold on, this could get bumpy
Ashley Seager Monday August 8, 2005 The Guardian
You may think that the housing market, whose foundations having been looking increasingly shaky over the past year, would be shored up by last week's interest rate cut from the Bank of England.
After all, you may say, rising interest rates did for the housing market last year and so the cut, the first for two years, must have the opposite effect. If money is cheaper, people might borrow more and start buying property again.
That is a dangerously complacent view. The house price bubble, the biggest this country has ever seen, was pricked last summer and has been losing air ever since. But it has barely begun to deflate in a serious fashion. It seems unlikely that the puncture can be patched up by an interest rate cut or two, let alone the bubble re-inflated, as some estate agents hope.
Let's be clear about this. House prices in Britain were massively overvalued, by as much as 50%, last summer when they finally stopped rising. As they have stood more or less still since then, the extent of that overvaluation has barely fallen. Prices had gone up 200% in the previous seven years even though inflation more generally was running at around 2.5% a year.
As a result house prices are still around six times average salaries, compared to a long-term average of 3.5 times. If prices were to stand still, it would take at least eight years for the long-term relationship to be re-established. It is hard to see that happening.
Since Mervyn King, the Bank of England's governor, warned in June last year that there was a danger of prices falling, prices have either been static or, in the case of London and the south-east, have begun to fall. Sellers are clinging to hopes of high prices, but are only selling if they drop their price.
And buyers are reluctant to buy now because they scent that the ball is back in their court and also because prices are still very high, which means a huge deposit. While an interest rate cut makes a mortgage slightly cheaper, it makes no difference to the size of the deposit required.
Interest rates were cut very sharply in the early 1990s but it took several years for house prices to turn up again.
The current housing market indicators are not universally gloomy, however. There is some evidence that the decline in activity - measured by buyer inquiries and mortgage approvals - may have bottomed out. But it is far from clear that this heralds any kind of upturn. It may just be a pause on the way down.
In fact, as Ed Stansfield at consultancy Capital Economics points out, there is a clear parallel between what has happened to mortgage approvals over the past year and what they did in the early stages of the last housing market crash - a strong fall, a gradual recovery for a while, then a slump. "It is absolutely spooky," he says.
The Royal Institution of Chartered Surveyors' monthly survey of surveyors - one of the most reliable housing market indicators - is still pointing to sharp price falls. And now, the main price indicators from the Nationwide and Halifax are showing annual price inflation slowing rapidly. The Halifax reported on Friday that prices were only 2.3% higher than a year ago, a nine-year low.
Fairly soon, probably in October or November, this annual rate could turn negative. There is no reason for it to stop at zero. Then any lingering pretence that bricks and mortar remain a rock-solid investment will have gone.
This could be a key psychological blow to the housing market. Over the past year, you could hear people saying things like, "My house price may have dipped this month but it is still 10% higher than a year ago."
And the knock-on effects on the economy could be grave. Already household spending has slowed sharply, as has mortgage-equity withdrawal, where people add to their mortgage to spend on other things. This has hit the retail sector hard and has slowed the whole economy down faster than the Bank of England had expected. This is why the Bank cut rates last week. Slower growth leads to slower inflation and its remit is not to let inflation slow too far.
So why should house prices fall? After all, say the optimists, there is no economic recession and no obvious trigger such as a sharp rise in unemployment or a sharp rise in interest rates, especially as they have now been cut. People don't have to move and so will just stay put and wait for prices to pick up.
I am not convinced by that. Prices, as in all markets, are set at the margin. In housing, about 7-8% of the market changes hands every year. Within that are always people who need to sell including, for example, builders of new developments. Recent results from housebuilders show that they have cut their prices 10% or more in some cases to lure in buyers. In private, many house builders are very gloomy.
Moreover, unemployment has started to rise, on the claimant-count measure at least, and employment has fallen slightly. That will not increase confidence in the housing market. And people are still saving very little of their income in historical terms. If people decide to save more, the economy and housing market could weaken further. If they think house prices are falling, they will be reluctant to buy.
To get a broader perspective on the house price bubble, it is worth looking at other countries. Britain's bubble is far from unique. Indeed, it is clear that the wave of interest rate cuts around the world in the wake of the bursting of the dotcom bubble five years ago, which saw shares tumble 50%, created a boom in housing instead.
All across the rich world, with the exception of Germany and Japan, house prices have been booming. The United States, France, Spain and Ireland are just a few of the countries that have seen double-digit property price rises in recent years. The resultant increase in (largely illusory) wealth has been bigger than the dotcom bubble.
And the correction now seems to have started in Britain, Australia and the Netherlands. Prices are still steaming away in France and the US and many other countries, but the warning signs are flashing. Prices in Sydney are down 16% in two years, according to international comparisons done by the Economist. Why shouldn't that happen in London, where prices are already down 3-5% on some measures?
But any way you look at it, it is clear the correction has only just begun.
In Britain the slowdown in consumer spending has occurred with house prices standing still. If and when prices start to fall, there could be trouble for the economy. The Netherlands is stuck in recession after its house price boom turned to bust a few years ago. The Japanese property market has been falling for 14 years since its bubble burst.
And don't be fooled by the apparently modest pace of the price slowdown in Britain over the past year. House prices moves tend to be slow rather than rapid. But once they have started, they gather momentum. Further gradual declines seem the most likely course and that is no bad thing, especially if you are a buyer. People need to be aware that asset prices can go down as well as up.
Rents, meanwhile, are likely to rise as house prices move sideways or downwards, pushing up rental yields from their current lows. A few people may choose to tuck a rental property into one of the new self-invested pension plans to be launched next spring but I doubt that will be enough to encourage a big wave of buying-to-let, which has fallen hugely in popularity this year as hopes of capital gains have faded.
It is, of course, possible that things really are "different this time", as the housing market optimists like to say. But all bubbles in the past have burst, and this one looks no different.
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Reply to
Funny isnt it, you doom merchants have been saying that house prices have *already* dropped precipitously over the last year or two, then one of you posts an article in support of your view that prices *will* fall, but the article says that prices have been stationary for the last year!
We are told by the doom merchants here, 'oh you should see whats already happened in my street in London over the past two years' but the article says that 'on some measures' prices are down 3-5%.
If you lot can't even work out what prices have *already* done, why would we expect you to have a clue what *will* happen?
[deliberate top post to leave original as reference]
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A report out today from Morgan Stanley estimates house prices overvalued by 30%.......
UK House Prices Remain Overvalued
The housing market correction may have a long way to go. Near term, the outlook for house prices, for transactions levels and for mortgage lending is significantly cooler than we have seen over the past five years. In our view, UK house prices probably remain overvalued, perhaps significantly so.
Updating our study from October last year, we find that many of our valuation measures suggest, if anything, an even greater degree of overvaluation now than last autumn. The longer-term outlook for owner occupation, demand for rental properties and the level of lending remain healthy, but over the coming year or so, falls in house prices would be unsurprising.
A near-term adjustment back to levels that are closer to estimates of sustainable values could happen in a quiet and orderly way, which is what the central forecast of our model predicts (on that projection, real house prices fall 5% over the next 12 months). But a much more volatile path back to fair value is also possible.
It is abundantly clear that the housing market has slowed very sharply and for the UK as a whole, average house prices have been fairly flat in real terms since the start of the year. But how house prices, housing market transactions and mortgage lending develop from here is hard to predict.
Periods after which nominal and real UK house prices have risen most rapidly (e.g. in the late 1980s) have been followed by periods when house prices fell significantly, relative to consumer prices. If that were to recur now, then given low consumer price inflation, nominal house prices would fall. However, because volatility is great from month to month, no-one can have much confidence calling the turn in the market based on a few months of flattish or even falling prices.
Average house price to income ratios remain at exceptionally high levels. But these measures ignore the cost of borrowing - a key determinant of housing demand. While the ratio of aggregate debt servicing to post-tax income for UK households is now much lower than at the peak of the housing market at the end of the 1980s, it is nonetheless well above the average over the past 20 years and has been rising steadily since 2002.
There is a strong argument that the right valuation measure is based on the difference between the user cost of housing and the value of owner occupation. The user cost approach to the valuation of housing is, in principle, fairly straightforward.
It rests on comparing the cost of owning a house for a period, say a year (for example, the cost of repairs, and the value of funds tied up in a house, which can be measured as the interest payable on a mortgage, less any capital gains) with the benefits (the value of rental services that home ownership generates).
If the user cost measure is higher than the implied rental value, houses are too expensive; if the two are roughly equal, prices look to be at a sustainable level. Based on the assumption that people are predominantly backward-looking in the way they form expectations on capital gains, houses look about fair value. In other words, if people think that prices over the next year will rise at the rate over the past year, then average UK prices are about where they should be. But if people think prices will be flat, houses look expensive.
There is another, related, way of thinking about equilibrium in the housing market and that is by comparing residential property as an investment asset against alternative financial assets - most obviously equities.
If one used the average ratio of yields on property and on equities in 2001, 2002 and 2003, then, based on a dividend yield now of around 3.2%, one would expect a net rental yield on UK property of a little under 4.7%. Since the actual net yield seems to be around 3.8%, that would imply an overvaluation of property of about 20%. If, however, it was reasonable to assume an improvement in the prospects of rental growth over the long term relative to dividend growth, then that degree of overvaluation could disappear.
Our own modelling suggests a gentle downward adjustment in house prices from today's levels, but the degree of confidence we have in that profile is not high. Our model says real prices will fall about 5% over the next 12 months and suggests that average UK house prices are now overvalued by around 30%.
One indicator of the extent to which house prices have posed affordability problems is that the number of first-time buyers has fallen. With buy-to-let demand appearing to slow, it is likely that more first-time buyers need to come to the market to play the role of marginal buyer and liquidity provider at the lower end of the market. In the absence of a sharp fall in interest rates this may require a significant price adjustment.
By David Miles, Melanie Baker and Vladimir Pillonca, Morgan Stanley economists, as published on the Global Economic Forum
Date: 09 August 2005
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I am shooting the people who in one post say that house prices have already dropped substantially over the past 1-2 years, then in another say they may have dropped 3-5%.
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30% would be a good start. Personally I suspect prices will have dropped more like 60% at the bottom of the trough: prices have just about tripled on average in a time of low wage-inflation, and crashes usually overshoot on the downside.
Reply to
Prices, averages anyway, might have not have moved much but the article also says "....sellers are clinging to hopes of high prices, but are only selling if they drop their price". It's a long article so there are pick'n'mix opportunities to suit all prejudices but asking/selling price anomalies have a lot to answer for in the current market debate. Prophets of doom or boom can yelp all they like but in an uneven market only those at the sharp end - completing buyers and sellers - can possibly judge.
The two main clauses in that paragraph are perfectly consistent. One is specific the other is some half-cocked undefined average.
They've gone up.
They're coming down.
Seriously, nobody ever knows what *will* happen but you don't have to be much of a sleuth to spot the clues and hazard a guess. Apart from localised blips, not too many are betting on rises at the moment. And then of course there's always the possibility of falls, big falls, crashes.....
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I'd expect falls, if and when these occur, to reflect rises. There's very little in London that's tripled. In my neck of SW London, prices were already quite swollen in 2001 and have added perhaps only 30% in the last 4 years.
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"Crowley" wrote
... hold that thought ...
... Ie, stay flat (see above) ...
OK, so it's saying that if people think that prices will stay flat, then they are about right (!).
Eh? They can't be both "about right" *and* "expensive", can they?
That's one possibility. Another is that rents are too low!
Reply to

both examples are specific to London. The people who said that prices had crashed, when asked where, referred to London. The 3-5% drop in the article is for London.
Reply to
Wasn't the 'crash' claim made by somebody talking about their own local area? London as a whole at 3-5% is still consistent.
Reply to

Its not consistent with the doomsters who have said that prices have already crashed in london by 20-30%.
Enough enny penny's have said the 'London' house prices have crashed (and many other areas) in order to support their case for falling prices and thus how right they were. I have no idea whether or not they have crashed (and dont have an axe to grind either way) , but am often told 'in my area', 'in london' , etc, prices have already 'crashed', with claims of anywhere from 20-30% being commonplace.
Those same people who post here that prices *have* crashed, then later post articles to the effect that they havent.
FWIW I dont recall any of the doomsters having sold their houses in order to make a profit after the crash. The *one* person who said he had, it turned out had been renting long term.
Famously a professor of economics who posted about a house price crash in The Times a couple of years ago, was still living in his house. And I'm betting you havent sold up and moved to rented either.
Reply to
Ah! Sorry - thought you were accusing one person of saying something inconsistent.
Bear in mind that bull predictions about the housing market are also inclined to be very mixed ranging from the modest to the absurd. There's no reason why doom-mongers should be any more inclined to sing from one sheet than the bullish.
I wouldn't have said common-place. A vocal minority.
Sure, they post articles from different sources. As the OP said, that's no reason to shoot the messenger.
The wisdom of selling on such a hunch has been broached here before - it's far from clear-cut.
I sold up and bought a house in France, but my partner sold in 2004 - a wise move as it turns out - and is renting while sitting on the cash and will buy when the time is right. Hopefully!
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My comment is that prices in Wales in the last 3 monts have significantly dropped. North Wales Coast 3 months ago similar properties to my parents were selling for 30,000 more than present estate agent valuation. Nothing is shifting now. The area has a very high turn over due to desirability.
Where I live the in South Wales, nr Cardiff again 40,000 off the prices properties similar to mine.
The local developers are knocking 20,000 off and the commencement of free carpets etc has returned.
It will be interesting to see if this is the leveller or a pause for a further dorp.
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selling prices...or advertised prices? I'm betting the latter. If you think the former, how do you know what they were *sold* for?
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Tumbleweed, from reading your posts you are a very optimistic person regarding the property market.
Being the anorak I am, the following web site gives me what I need.
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cheers alan
Reply to
In message , physman writes
Cool site - seems to show more properties than the free one I use, but not sure I would want to pay unless I had a specific use for the info, rather than merely interest.
Reply to
Richard Faulkner
Perhaps you could define optimistic in this context for me. What do you mean by it. What do I mean by it?
For example, is it house prices up or down, and why that would be optimistic from my POV. And then show where I have forecast what house prices will do.
Good luck.
Reply to
p.s. try nethouseprices, it doesn't charge.
Though the last time I looked, neither of them would let you enter a future date in order to determine what will happen or when, if ever, the 'bubble' will 'burst'. Perhaps you have to register for that feature?
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