The UK house price ‘bubble’

by George Hatjoullis

A very interesting article in the FT (http://on.ft.com/1hSXMZk) highlighted that in real terms (adjusted for inflation) UK house prices are still well below the peak of 2007. This is true of Greater London as well as the whole kingdom. So why do people speak of a ‘bubble’? One reason is that the ratio of house prices to average earnings is still very high, though lower than it was at the peak of 2007. For the whole country (using the Halifax data) the ratio was 4.66 in September 2013 compared to 5.77 in September 2007 and 4.84 in September 2008. It could be argued that the ‘bubble’ was in 2007 and has already burst. Enter mortgage costs. Halifax estimates that mortgage costs were 46.2% of income in Q2 2007 and 42% in Q2 2008 compared to 27.5% in Q2 2013. House prices are clearly more affordable today than they were back in 2007 but the reason is mortgage costs rather than house price levels or income. If mortgage costs rise many house owners with a mortgage could find themselves stretched.

The forward guidance offered by the Bank of England does not however take into account mortgage costs. It uses inflation and unemployment as its ‘knockout’ indicators. Interest rates will be reviewed if the unemployment rate drops to 7% and the inflation rate is sticky above 2.5%. Both are very likely and without real incomes necessarily growing. It is not difficult to see a situation arising in which mortgage costs as a percentage of income start to rise in the foreseeable future. Herein lies the risk to the housing market. Even at current prices and incomes the government sees a need to help first time buyers enter the housing market. The implication is that for many it is a stretch. How much more so if mortgage rates then rise? The Bank of England has set up policy based on aggregates that may not allow for stresses in the housing market.

The press hype about housing as an investment also does not seem to fit the facts. The RPI has risen by 21.1% since September 2007 and by 15.3% since September 2008 (to September 2013). The FTSE has risen by 0% and 30 % respectively. The average UK house price has managed -14% and 0% respectively. The figures for Greater London are not much different. The yield on the FTSE over this period has been commensurate with rental values. Index-linked gilts and equities would have served the investor better than a typical property in the UK. Of course, averages obscure much variation. It has been possible to do better in housing by picking the right areas. However, it has also been possible to do better in equities by selecting the right stocks or sectors. Relative value arguments cannot obscure the basic point; housing as an asset class is not quite as good as the press hype would have you believe. What about the future?

If interest rates rise then the fortunes of the housing market depend upon real earnings growth. The latter is not necessarily a negative for equity markets. It depends upon how the real earnings growth comes about. On balance, it is easier to be optimistic about equity prices than house prices in most scenarios that trigger a rate increase by the Bank of England. Moreover, equities are more liquid and easier to trade and exit. There is no bubble in house prices but it is not the best investment class either. If you need a home then buy a home but don’t speculate in housing.

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