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House price bust is not over

Ed Bowsher
by Lovemoney Staff Ed Bowsher on 29 May 2009  |  Comments 1 comment

Could house prices have reached bottom?

My view on house prices is simple. I think they have further to fall - another 10% decline looks likely to me. And I think it's fair to say that many economists and pundits broadly agree. 

So I was interested to read a blog post today that goes against the consensus. The author is Simon Ward, an economist at Henderson New Star. 

Ward's argument is based on the average rental yield on UK properties. He's calculated that the average yield between 1965 and 2007 was 3.6%. The current yield is 3.8%, so, according to Ward, that means that house prices are slightly undervalued at the moment. Wow, that's quite a claim! Does that mean house prices are set to start rising again?

Well, the obvious response is that markets tend to overshoot in booms and undershoot in busts. In other words, history suggests that house prices will carry on falling even though the rental yield is slightly above its historical average.

Ward, however, disagrees. He reckons the housing market won't undershoot in this slump. He points out that interest rates are much lower than in previous busts - that means that many struggling borrowers will be able to carry on servicing their mortgage. As a result there will be less distressed selling, and the average rental yield won't rise as much as it did in earlier slumps. So, if you agree with that, house prices are at or near the bottom. 

It's an interesting argument which will no doubt comfort property investors. Property bulls will also point to today's figures from Nationwide which say that house prices rose 1.2% in May. 

I'm more sceptical though. Taking Nationwide first, I don't think a number from one particular month is terribly significant. Markets don't move in a straight line. 

As for Ward's argument, my belief is that unemployment has much further to rise and that will trigger more house sales - regardless of low interest rates. I also suspect there is a lot of pent-up housing supply. As soon as house prices move up a little bit, more homes will come on the market and that will push prices back down sharpish.

The next couple of years are going to be fascinating. Who is going to be proved right? Ward or me? What are your thoughts? Add your comments in the box below.

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Comments (1)

  • Swarbs
    Love rating 272
    Swarbs said

    Hoorah, first post (if I'm quick!). Just goes to show that for every

    meaningless negative statistic (price to income multiples) there is an

    equally meaningless positive statistic (average rental yields). The "the

    average yield between 1965 and 2007" may have been 3.6%, but that

    figure, just like the price to income multiples every bear seems to

    love, will change over time with supply and demand. The same way price

    to income multiples have increased over time due to an increasing

    shortage of properties, so rental yields have been driven up by the

    same factor -> more people renting less properties = higher rental

    yield per property.

    Personally, my feeling is that

    the next few years will tend to go sideways and slightly upwards.

    Economically, house prices behave in a manner consistent with "sticky

    downward" economics. In other words, prices are much less likely to

    fall, and fall much slower than expected, in the absence of

    overwhelming market forces. Whilst unemployment will drive prices down,

    even if unemployment reaches 10%, that's still only around three

    million people, and there are currently three million fewer properties

    than households in the UK. Mortgage payment insurance is now also much

    more prevalent that in previous busts, which provides a further safety

    net. Ultimately, unless interest rates rise rapidly making houses very

    unaffordable, the economic forces are unlikely to prove overwhelming

    enough to overcome the sticky downward tendency. And given that the

    BofE currently projects CPI below target until 2012 based on current

    interest rate expectations, something would have to change markedly to

    cause a rapid rise back to early 2008 levels. Heck, even if something

    did, the BofE is so slow to react that interest rates would still take

    a while to come back up.

    Indeed, my view is that the

    only reason prices have fallen so sharply this year is that one sector

    of the housing market is resoundingly not sticky downward - new builds.

    Most new build developers have been fireselling all their completed

    stock at discounts of 25%-50% from 2007 prices for the last year. With

    most other homeowners not selling, housebulders have dominated the

    market and forced it down by offloading so much stock so quickly. Now

    that they are mothballing all planned developments and sitting on their

    landbanks, this downward pressure will disappear, and we'll get a long

    period of sideways movement where sellers refuse to drop their prices

    and buyers refuse to raise them. Then within two or three years thecurrent government will go, the economy will improve

    and prices will come back to 2007 levels and carry on from there, in

    the absence of any major interest rate rises or changes to the planning

    laws in the UK.

    Report on 17 June 2009  |  Love thisLove  0 loves

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