Is the housing market bubble about to burst?

’Britain faces 20-year house boom that will split nation’ reported The Guardian newspaper in June 2007. Whereas economists struggle with 3 year predictions, The Guardian has managed a 20 year one! In the long term house prices (like shares) tend to go up, but just like the investor who bought Japanese shares in 1990 when the stockmarket was at 39,000, this is no consolation when the index is now half that. The Guardian’s headline is exactly the kind of drivel you get at the top of a market!

Here are 6 factors likely to push house prices lower in the next few years?

1. Interest rates
   Interest rates are currently at 5.75% and heading for 6% (if not 7%). If we look at real interest rate (that is, rates adjusted for inflation) with a RPI at 4.3 and base rate at 5.75 gives a real interest rate of 1.45%. Historically real interest rates have been about 3% therefore a base rate of 7% is a realistic proposition.
   
   In the next 18 months approximately 2 million fixed rate mortgages will expire most of which will need to be re-fixed at a higher rate. The Property crash of the lates’80s/early 90’s followed a rise in rates from 7.5% in May ’88 to just under 15% in October 89 (ie double). In the Summer of 2003 rates were 3.5% so a rise to 7% would also represent a doubling. Of course 7% is still ’historically’ a low rate, but the average property in 1989 was about £65,000 as against a average price now of £220,000.¹
    
2. Easy credit
   The ’dotcom’ style collapse of the subprime mortgage lending in America has signalled the start of their property slump. At one time marginal applicants would have been refused credit as the risks would have been assessed properly. Thirty US sub-prime lenders in the past few months have gone under at huge financial cost to lenders ². House prices in America have started to fall as more properties come onto the market at a time when less people are able to afford them (due to tighter credit and higher rates). Lenders in the UK have been almost as casual in their lending as their US counterparts…
    
3. Extreme lending
   In 1995 the average UK house price was about 2.5x earnings. Some mortgages are now calculated on up to 6 times salary and lenders like Alliance and Leicester have introduced 40 year mortgages. This is very familiar territory for anyone who remembers the bursting of the Japanese property bubble in the early 1990s. People were falling over themselves to buy property at any price (because property always goes up!!!) and were willing to borrow on a ridiculous salary multiple - the phrase ’two generation mortgages’ was also introduced to the world. The office of one Japanese bank in London in 1997 had an ’informal’ competition to see who was the person who had lost the most on their Tokyo flat - one ’banker’ reckoned his property, purchased for around $1,000,000, was now worth about $200,000 - an 80% fall!
    
4. Buy-to-let yields
   Buy-to-let yields have fallen. Before long there could be a ’tipping point’ where landlords decide that the return on selling a property and banking the money at a juicy savings rate would produce a much higher return (and a lot less hassle) than renting a property. As landlords simultaneously head for the exits there will be a sudden deluge of properties for sale. Tenants, on the other hand, could start to pick and choose between properties and/or start to demand lower rents (re. 1989-93). If you are a buy-to-let landlord, this scenario should be giving you sleepless nights.
    
5. Supply of new homes
   Gordon Brown wants to increase new homes supply to around 200,000 pa (currently 160,000). Since very few houses get demolished, there will be extra supply at a time of falling demand. Even house price builder Bovis plc is cautious having ’experienced a recent slowdown in both visitor rates and in reservation rates’. They build houses… they should know
    
6. External factors and the economy
   There has been a healthy UK economy for more than 10 years and Gordon Brown has so far avoided the boom-bust of most the post war era. There are some signs that the good times could come to an end (the gift of the Chinese economy helping to drive down UK inflation, the consumer spending boom and low oil prices are all factors now fading fast. The Middle East could still provide the killer blow to the UK economy) in the next two years, either Iran will get nuclear weapons or Israel (& the USA?) will see to it that they dont. Whilst the former is not exactly goods news the latter would certain see oil prices surge 1970s style as Iran would likely close the Straits of Hormuz. $200 barrel oil would be on the cards with devastating economic effects.
   
   

July 15 2007, © DCE

Other links
For anyone who has forgotten the last house price slump have a look at the Spitting Image video on YouTube:

Bank of America predicts 20pc probability of a ’severe crash’ (Daily Telegraph)

 

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¹ FT House price index
² The likes of Bear Stearns, HSBC etc

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