Where do house prices go from here?

The figures tell us that house prices are unsustainable at current levels and are likely to head dow

A big question is: where do house prices go from here? According to Halifax, house prices peaked in December 2007 and have fallen 17 per cent since then. Real house prices have fallen even further -- by around 27 per cent. Homeowners on trackers have done really well. Their payments fell sharply as interest rates fell to historically low levels after the Monetary Policy Committee (MPC) cut the Bank of England rate to 0.5 per cent. This has kept delinquencies down but it is unlikely to continue when interest rates rise. This will inevitably have a downward impact both on house prices themselves and, inevitably, on consumption also.

Based on house-price-to-earnings ratios (HPE), a measure of affordability, it does look as if house prices are unsustainable at current levels and hence still have quite a long way to fall.

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Chart 1 (click here for a bigger version) illustrates this, using data from the Halifax. The index stands at 4.45, compared with a peak of 5.81 in July 1987 and a long-run average from 1983 to 2000 -- prior to the house price boom -- of 3.64. The question is by how much. These numbers suggests that house prices have another 20 per cent or so to go, with the concern that, as has occurred in other house price corrections, there is a bigger overshooting before prices return to the long-run equilibrium. Interestingly, a comparison of gross rental yields, relative to a long-run average, also indicate that housing is at least 20 per cent overvalued.

But claims about the sustainability of HPEs come up against the counter-claim that low interest rates have made valuation metrics less useful as a guide to the sustainability or otherwise of prevailing house prices. Compelling new work by Paul Diggle from Capital Economics sheds some light on this issue. He argues that comparing house prices to equity prices, which should also have benefited from low interest rates, still suggests that house prices are about 15 per cent too high.

There are similarities, he suggests, between how equities and property "should" be priced. As a claim on a company's future earnings, the price of a share, he claims, should equal the present discounted value of the expected earnings to which it entitles the owner, with a suitable allowance for risk. An equivalent way of determining the "fair value" price for property is by using the present discounted value of the future stream of rental income, adjusted for risk and the costs of owning and maintaining property. So, Diggle argues, by lowering the rate at which future income is discounted, low interest rates should have benefited both asset classes. Even so, relative to a simple long-run average, the ratio between house prices and equity prices seems to suggest that either equities are around 15 per cent too cheap or housing is around 15 per cent too expensive. (See Chart 2 -- click here for bigger version).

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Given that the FTSE all share price/earnings ratio indicates that stock market valuations are very close to average historical levels, Diggle argues, there is little evidence for the former. The house-price-to-equities ratio seems to imply that house prices are higher than can be justified by low interest rates.

It is significant that the extent to which housing is overvalued on this new measure is similar to other measures, such as the HPE and rental values. The house-price-to-equities ratio adds to the case that a downward adjustment in prices is required. House prices look to be headed down.

David Blanchflower is economics editor of the New Statesman and professor of economics at Dartmouth College, New Hampshire

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When Donald Trump talks, remember that Donald Trump almost always lies

Anyone getting excited about a trade deal between the United States and the United Kingdom should pay more attention to what Trump does, not what he says. 

Celebrations all round at the Times, which has bagged the first British newspaper interview with President-Elect Donald Trump.

Here are the headlines: he’s said that the EU has become a “vehicle for Germany”, that Nato is “obsolete” as it hasn’t focused on the big issue of the time (tackling Islamic terrorism), and that he expects that other countries will join the United Kingdom in leaving the European Union.

But what will trigger celebrations outside of the News Building is that Trump has this to say about a US-UK trade deal: his administration will ““work very hard to get it done quickly and done properly”. Time for champagne at Downing Street?

When reading or listening to an interview with Donald Trump, don’t forget that this is the man who has lied about, among other things, who really paid for gifts to charity on Celebrity Apprentice, being named Michigan’s Man of the Year in 2011, and making Mexico pay for a border wall between it and the United States. So take everything he promises with an ocean’s worth of salt, and instead look at what he does.   

Remember that in the same interview, the President-Elect threatened to hit BMW with sanctions over its decision to put a factory in Mexico, not the United States. More importantly, look at the people he is appointing to fill key trade posts: they are not free traders or anything like it. Anyone waiting for a Trump-backed trade deal that is “good for the UK” will wait a long time.

And as chess champion turned Putin-critic-in-chief Garry Kasparov notes on Twitter, it’s worth noting that Trump’s remarks on foreign affairs are near-identical to Putin’s. The idea that Nato’s traditional purpose is obsolete and that the focus should be on Islamic terrorism, meanwhile, will come as a shock to the Baltic states, and indeed, to the 650 British soldiers who have been sent to Estonia and Poland as part of a Nato deployment to deter Russian aggression against those countries.

All in all, I wouldn’t start declaring the new President is good news for the UK just yet.

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to British politics.