House prices will soon fall again

There remains a glut of houses on the market. Lower demand will lead to lower prices

I flew back to Boston on Thursday last week and "she who must be obeyed" met me at the airport with our charabanc and the dog. Fifty hours later we were in south-west Florida and the temperature was 80° in real money. In total we drove about 1,400 miles. The high point was a motel stop in Florence, South Carolina, at a place we found on, which worked well. Better than the first place we rang, which said it was dog-friendly but the charge for the dog was more than for us.

The other highlight was seeing billboards advertising vasectomies with the stunning line "No needle, no scalpel". As the journey proceeded, the numbers of clients they claimed to have neutered increased - first 10,000, then 16,000, and finally 20,000. It was never clear, though, if they meant dogs or human beings.

Also memorable were recession-style billboards, including "Empty your suitcase not your wallet" and "El Cheapo Fuel Stop". We were especially taken by the Holy Land Experience in Orlando, which promises to take you back 6,000 miles and 2,000 years for a ticket price of $29.75, but it closed at 6pm. Next time.

Small island

My mind turned to house prices in the UK after looking at the astonishing rate at which they have fallen in parts of southern Florida. In Cape Coral, prices have fallen by nearly two-thirds and roughly a quarter of houses are in foreclosure. The average house price is $97,000, down from about $255,000 in January 2007. According to the S&P/Case-Shiller 20-city index, house prices in the US as a whole fell by 32.6 per cent between the peak in the second quarter of 2006 and the trough in April 2009. There has been some recovery in the past few months, largely as a result of government subsidy; the index is now down 29 per cent from the peak.

I continue to puzzle over how house prices could possibly have increased in the UK last year and why the falls are much smaller than in the US. Prices rose 6 per cent here during 2009, according to both the Nationwide and Halifax indices. The peak-to-trough fall on the Halifax index was around 22 per cent before the rise. Given the fragile state of the economy, prices really should still be falling.

There is an obvious concern about the reliability of the data, because the market is thinly traded. There are many fewer houses being sold than for many years, and the mix of types being sold is different from the past, which makes comparisons across time difficult. Auction prices have fallen much more than the Nationwide or Halifax indices.

There are various reasons why prices could have increased. One is that the weak pound makes houses an attractive investment, especially for holders of euros. But this is likely to be more important in London and the south-east than in Hartlepool or Bradford. Consistent with this, the growth in house prices is much weaker outside London and the south-east. Another reason is that Britain is a small island and there aren't enough houses for everyone who wants one. An inadequate supply pushes up prices. Plus, low interest rates have helped to lower the cost of owning a house.

But there are more compelling arguments for believing that house prices should be falling, rather than rising. Or, at least, that they would fall sharply if interest rates were to start rising any time soon. Wages are down and are likely to remain low for a long while. Most private-sector wage settlements are now freezes or even cuts. There is a wage freeze in the public sector. Incomes of the self-employed have fallen markedly, especially in construction, which dominates. Non-labour incomes are also down. The decline of self-certification mortgages is likely, in effect, to have diminished incomes, and hence demand.

There remains a glut of houses on the market. Lower demand with higher supply tends to lower prices, I tell my students in economics for beginners. Hundreds of thousands of workers from the EU accession countries, principally Poland, have also returned home, easing pressure on rents and reducing the demand for housing more generally. This has especially affected the buy-to-let market.

Furthermore, as in the US, the availability of credit is also way down, which will limit the number of homebuyers. The size of required down payments has risen.

Back to the trough

Finally, it seems that part of the explanation for the apparent rise in prices is that those houses sold are not being accounted for adequately
by type. There tends to be considerably more variation between detached houses at the top end of the market - for instance, mansions, castles and country estates are all in the same category as newly built, four-bed detached properties with no garage - than between terraced houses. Also, houses that have declined the most in price are the least likely to be sold, especially if the owner has a significant amount of negative equity. The closer to the peak the loan was taken out, the more likely this is.

Evidence from of the numbers and prices of houses sold by type - detached, semi, terraced or flat - in Greater Manchester, using data from the Land Registry (see table below), supports this view. The number of detached houses sold over the past 12 months increased by 64 per cent, whereas the number of flats fell by 27 per cent. At the beginning of the period, more flats sold than detached houses, but by the end the pattern had reversed. It seems this is repeated in many parts of the UK.

blanchflower table

Recent data points to the market slowing again. In December, the Royal Institution of Chartered Surveyors reported that the sales-to-stock ratio fell for the first time in a year. And surveyors' sales expectations have plunged to a 12-month low. We will see.

I still remain fairly pessimistic for the UK housing market. The worry is that prices will start to turn down again in 2010. I fully expect a peak-to-trough drop of at least a third when all is said and done. So why am I wrong?

David Blanchflower is the Bruce V Rauner Professor of Economics at Dartmouth College, New Hampshire, and the University of Stirling