Sorry for posting the entire story. I don't know how to post a link
Fasten your seatbelts and prepare for the property market to land
Monday August 30, 2004
Can anyone afford the house they are living in? Or, put another way, could you afford to buy your house or flat if you had to buy it right now at today's price? The question might sound odd but it is worth asking after a seven-year period in which property prices have tripled.
It is likely that for the vast majority of people, the answer would be a resounding "no", especially because the Bank of England has raised interest rates five times since November to the current 4.75%.
There are many other measures showing that houses have become too expensive, including the good old house prices to average earnings ratio, the house prices to GDP per head ratio and so on.
All of them point to an overvaluation of anything from 20% to 50%. But, even without those methods, common sense dictates that rises of 20% and 30% year after year cannot continue for ever, especially when inflation has been running at 2-3% a year all that time. This is not rocket science.
Now, however, after years of gravity-defying rises, the day of reckoning appears to be with us. If truth be told, we knew this would happen at some point.
After all, first-time buyers packed up and disappeared early last year. Without them to prop up the market, it was just a matter of time until it ran out of steam. In some ways the only surprise is that it took this long.
At the height of a boom, data are often muddled and inconclusive but the most recent numbers are showing that the tipping point has been reached.
Last Thursday's mortgage approvals data from the British Bankers' Association - a good guide to activity in the housing market - fell back 20% in July from June and were 20% lower than the same month a year earlier. Nasty.
A monthly survey of estate agents by Hometrack showed a small monthly fall of 0.1% in prices, with demand dropping sharply.
The Royal Institution of Chartered Surveyors reported earlier in the month that the market had ground to a halt after the spring surge which looks to have been the last gasp of the great noughties housing boom.
True, the major indices from the lenders Halifax and Nationwide are still showing monthly price rises, and may continue to do so for a little while yet. But their underlying, three-month on three-month rates of increase have eased back too.
So the million pound question is where do we go from here? Do we stand on the edge of the abyss, the great noughties housing market crash, or will house prices behave sensibly and just remain stable or dip a bit over several years, allowing inflation and average earnings to catch up? To use the jargon, will there be a hard landing or a soft one?
In terms of expert opinion, there is little better than that of Bank of England governor Mervyn King. But, as he said recently, he has no idea and nor, he added, does anyone else.
But Mr King did warn that one of the key "downside risks" in the monetary policy committee's inflation forecast was house prices and their potential effect on consumer spending.
Mr King is not just an observer like the rest of us, though. His role in topping out the housing market could be talked about for many years, rather as Alan Greenspan's "irrational exuberance" speech of 1996, about the dotcom boom, still is today.
Mr King, having spent the past year issuing unheeded warnings that the pace of house price growth was unsustainable, said in mid-June that those prices had risen so far there was a danger they could even fall.
That sent a shudder through the market, from which it has not recovered. Estate agents everywhere say the warning chased buyers out of their offices in droves. Mr King's words could go down in history as the pin that pricked the bubble.
Mr King is walking a tightrope. His aim was to deflate the housing market gently rather than have the bubble burst spectacularly. Apart from wanting to prevent a burst destabilising the whole economy, he is aware of the damage it could do to the Bank's credibility.
A soft landing is not only in the Bank's interest. It is also crucial for the Treasury. Gordon Brown, having won years of praise for handing responsibility for rates to the Bank, could see the decision come under scrutiny again. There is a general election coming up next spring. A housing market collapse would hardly endear the Labour government to the middle classes.
So how likely is the soft landing that the authorities, and homeowners, would like to see? Most housing market experts think it is the most likely scenario.
This is because, they say, there is no obvious trigger to set off the sort of sharp falls in real, or inflation-adjusted house prices that the country suffered in the early 1970s, early 80s and early 90s, even though we are in the early 2000s and a pattern looks alarmingly established.
The previous three slumps, say the optimists, were preceded by very sharp interest rate rises and coincided with periods of economic slowdown and rising unemployment. None of these conditions is in place this time, they say.
The soft-landing camp also says house prices have risen a long way but partly because they had fallen a long way after the slump of the early 90s. Add in the fact that we moved in the early 90s to a period of low inflation and low interest rates, some sort of one-off shift upwards in house prices was entirely logical.
They point also to the London market, much of which has been steady for the past two to three years while prices in the north have been rocketing.
Yeah, yeah, yeah, say the pessimists, that's all very well but this is a bubble like any other and will burst like any other. The dotcom share boom did just that at the turn of the millennium without any obvious trigger such as a recession. Shares dropped by half.
The claim from the soft-landing camp that it is different this time is typical of the overoptimism that sets in during bubbles, they add.
Also, says Ed Stansfield, a leading bear at consultancy Capital Economics, interest rates may have risen from 3.5% to the relatively low level, in historical terms, of 4.75% and look to be close to their peak. But that is a 35% rise and if they go up to 5.25% by early next year, as many economists think, they will have risen 50%.
That would hurt borrowers who took the biggest loan they could afford when rates were rock bottom.
The London market may have simply stabilised at the top of a boom and held there because strong rises in the north of England were keeping the Nationwide and Halifax numbers in positive territory.
Pessimists are also unhappy with the idea that houses are different from shares because they are not so easily traded and people will just sit in their house and not move if there is talk of weaker prices.
In fact, house prices are set by the 7-8% of the housing stock that is sold each year and some people will always have a reason to sell. If they have to cut their price sharply to do so, they will cut their offer price on the property they are moving to.
This brings in the other type of property owner, the buy-to-let landlord. This person bought in the hope of capital growth and might well sell if prices start to fall, putting further downward pressure on the market. These are the people who can succumb to the old market drivers of fear and greed.
The Bank of England has identified this as its key worry. It got its regional agents to survey landlords this summer and concluded that most buy-to-letters were financially sound, had relatively low loan-to-value ratios and were in it for the long term, suggesting they would not panic sell in a downturn. "But this conclusion is by no means certain," the Bank said.
Figures show that, contrary to popular belief, the buy-to-let phenomenon has not increased the stock of homes to rent in recent years because commercial landlords have been reducing their holdings. The private rental sector is still only about 10% of the housing stock.
But the buy-to-let craze is fading, anyway. The growth in buy-to-let mortgage lending has slowed, which is no surprise given the collapse in rental yields - the value of the property divided by the annual rent - to, in most cases, below the level of interest rates. In other words, rents are no longer covering mortgages. Without the promise of capital gain, buy-to-let no longer adds up.
Another problem that worries the bears is that previous adjustments in real house prices back to their long-run relationship with average earnings have been disguised by high inflation. House prices in nominal terms have fallen somewhat over a two- or three-year period but high inflation has made up the difference.
In a period of very low inflation, such as now, an adjustment in real terms could require a much bigger fall in nominal, or actual, house prices than in the past. And that would be painful.
The next couple of months are likely to be crucial in determining whether we get a soft or hard landing. There is usually a back-to-school pick-up in buyer interest in September and that could recur, especially if people take on board the Bank of England's recent hint that rates are close to their peak. But if that does not occur, and the major Halifax and Nationwide indices start to show monthly falls, judgment day may be nigh.
As Darren Winder at UBS bank in the City says: "There is clearly going to be a correction. How big it will be, Lord only knows."
What goes up must come down.
I know where I am placing my bet