Robert Budden: Optimism still fuels house price engine

It’s been a while since we’ve seen any big name doomsayers on the UK housing market.

Just a few years ago you could take your pick. In late 2002, Roger Bootle (previously chief economist of HSBC) and his lot at Capital Economics were predicting falls in house prices of around 20 per cent.

In April 2004, the International Monetary Fund said in its World Economic Outlook report that there was a “likelihood of a sharp price correction” in the UK. And in the same month Tony Dye, head of Dye Asset Management, who had earned the title of “Dr Doom” by forecasting – albeit a little prematurely – the dotcom collapse, warned that house prices were in line for a fall.

However many of these bears did not stay around for long. Towards the end of 2005, Capital Economics changed its tune. It felt that it had underestimated the impact that lower nominal interest rates would have on the housing market.

It also believes that more generous lending from banks and building societies, which means that many people can now borrow five or even six times their salary, has had a significant upward impact on prices. It now believes that house prices are likely to edge up next year and in 2008, although these rises, it believes, will be slightly behind earnings growth. This is hardly a doomsday scenario.

But this week a bear dared to put its head above the parapet. David Miles, chief UK economist of Morgan Stanley and a former adviser to Gordon Brown, warned that a house price bust is likely in the next few years. Now this is the stuff that headlines are made of.

Miles argues that real house prices have more than doubled over the last decade. Over the period, using figures from the Halifax, the average house price has nearly tripled from around £66,000 to £185,000. After allowing for inflation, this equates to a real price rise of 112 per cent over this period. At the same time, GDP has grown by “only” 31 per cent and the real disposable income of households by 29 per cent. You don’t have to be an economist to work out that such house price rises are unsustainable.

But does it mean we are headed for a crash? Certainly on many conventional valuation measures house prices look toppy, according to Miles.

Whether it’s house prices relative to income or house prices relative to rents the graphs tell a similar story. Both show valuations stretched some way above previous highs reached at the end of the 1980s. Similarly, and rather worryingly, mortgage possession actions (although not actual repossessions) in the first half of 2006 edged closer to 70,000, not far off the peaks of just over 90,000 for many six-month periods in the early 1990s. In the second half of this year, we have had two quarter point interest rate rises which can only be adding to the pressure for some borrowers.

The costs of servicing mortgage debt has also understandably been rising. Miles notes that for first time buyers total mortgage repayments now account for around 23 per cent of income, up from around 15 per cent in the mid 1990s. This compares with peaks of just over 27 per cent in the early 1990s just before the housing crash.

The key difference between then and now, of course, are interest rates. The fact that first-time buyers are already feeling the strain even though interest rates are only around a third of the peak levels under the Tories would be a cause for concern were it not for the fact that even the most pessimistic assumptions are that interest rates will peak at six per cent next year.

Clearly, though, there must be little room left for manoeuvre. Lenders cannot increase their lending multiples much more and with interest rates rising, in many parts of the country, the balance is starting to tip in favour of renting rather than buying once again.

You would expect on these factors, therefore that house prices would be begin to fall or at least stabilise. One factor that negates this is the strong demand versus limited housing stock.

Another, Miles argues, are anticipated rises in property. First-time buyers and buy-to-let investors don’t mind shouldering high mortgage costs if they expect prices to keep on rising. Indeed when this happens, it reduces the cost of home ownership.

Miles believes that buyers are continuing to bank on price rises of 10 per cent a year. I suspect that this emotional element is a big driver behind continued house price rises.

rob.budden@ft.com

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