London Calling at the Top of the Housing Boom

For the British, our homes have been more than dwellings, they have been gold mines. Over the past 10 years real (inflation-adjusted) UK house prices have doubled, while real disposable incomes have risen by only 29%. Latest figures available show that in 2005, housing made up 53% of the total wealth of UK households, compared with 39% 10 years earlier. Yet again we have been told, the housing boom cannot last and the end is nigh.

A major contribution to the debate comes from David Miles, former advisor to Gordon Brown. He says a UK housing bust is “likely in the next few years” because house price growth has been grounded in unrealistic expectations of double-digit annual increases. Once house price rises come down below expectations, he thinks, significant falls are likely. But he is reluctant to put his neck on the line regarding when this will happen. He says “A sharp fall in real house prices is likely at some point in the relatively near future, though it could be one or two years away”.

Indeed Mr Miles himself admits that his model shows why trying to call the housing market over the next year or two is “pretty much hopeless”. So there we have it, like those who tell the time from a stopped clock, the people who predict that British house prices will tumble may be right one day. But it has been a long wait and to date it has been wrong to take their advice.

Indeed, talk of a house price crash in the current cycle is already over 10 years old. In 1996 Bob Beckman, the self-styled property market bear, predicted a 20-year fall in UK house prices. Then in 1997 some commentators feared that a Labour win would hit prices hard. The September 11 attacks persuaded many, but not us, that the housing market was about to dive.

Professor Oswald urged British homeowners to sell up in May 2003. Capital Economics forecast that house prices would fall by 20% from 2004 to 2006. Not to be outdone, in February 2004 stockbrokers Durlacher issued a report warning of a 45% decline in house prices even if unemployment and interest rates remained the same! But we have always maintained the view that the housing market would have to be the victim rather than the assassin of the British economy. Accordingly Durlacher’s forecast turned out to be more doomed than the property market.

Every previous crash in UK house prices, in the early 1930’s depression, in the stagflation years of 1973-76 and most recently the early 1990s were accompanied by a severe recession. The crash of early 1990s followed a doubling of interest rates to 15% and a near doubling of unemployment from 1.6m to 3m. So with Britain enjoying

57 successive quarters of growth there is no reason to believe that a house price crash is imminent. History also tells us that the scale of house price crashes, though painful for those that bought at the top, has been quite modest. Both in the early 1930s and early 1990s the fall in house prices from peak-to-trough was only 13%.

Mr Miles’ thesis however does not require the economy to be the assassin of the housing market. He believes that when house price inflation fails to meet expectations, demand for housing will fall. But surely sellers will not cut prices unless forced to do so by economic circumstances.

Most house moves are voluntary. If homeowners are faced with selling at a price they consider to be too low, they are more than likely to withdraw the property from the market. This is why when the property market is overvalued the correction tends to take place by means of price stagnation rather than a crash.

Asset bubbles emerge when the dominant motive for purchase is the expectation of selling on soon to someone else (a bigger fool) at a higher price. The bubble collapsed because the market ran out of bigger fools. Now as far as housing is concerned, despite the growing popularity of buy-to-let and second homes, the overwhelming majority of those who buy property plan to live in it. The motives for buying are different from stocks.

For five years now, the expert consensus that UK property prices are overvalued has rested on one central observation that the ratio of house prices to incomes is historically high. Of course you would expect a share price on a demanding price-earnings ratio to revert back to its long -term norm, but what about houses? Houses are different. They are both an asset and a commodity.

Let me explain. The primary purpose of a house is to provide shelter. Consider the market for real estate in Idaho or Nebraska. There is more land there than anyone could wish to build on and usually there is not much to choose between the prestige and convenience of different areas of spacious cities. In these areas house prices are low, stable and tend to move in line with income.

Now consider London or Manhattan. Most of the price reflects the location rather than the accommodation.

Transfer a mews property in Belgravia to Paisley in Scotland and it would lose most of its value.

You cannot make more houses in Mayfair or East 69th Street, so the prices of properties in prestigious areas resemble the price of a commodity in short supply. The aspirant rich do not displace the very rich from the most prestigious locations but they make the very rich pay more for them. Unlike a share in BP, houses in prime locations are also a symbol of status and prestige and that is why the housing market does not conform to simplistic valuation models. This is why forecasts of a house price slump are about as useful as a stopped clock.


Brian Durrant
for The Markets and Money Australia

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Brian Durrant
Brian Durrant has a Masters degree in economics from Cambridge University, followed by nearly 25 years' experience in the City. In the 1980s Brian worked with Tim Congdon in the economics department of stockbrokers, L. Messel & Co. And in the 1990s he was Head of Research at GNI, the leading futures and options broker, specialising in exotic options strategies in foreign exchange markets.
Brian Durrant

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