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Extradry Martini

A Concrete View On Uk House Prices

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About a year ago, I made some very rough predictions here on how far nominal house prices will fall from the 2007 peak before they bottom and recover. These were based on how far I expect/ed house prices to fall versus average earnings (my most confident variable), what inflation and real house prices will be for the period of falling prices, and how long that period would be. The upshot was somewhere between 35% and 50%. As we get closer (note: “closer”, not “close”) to the end of the bear market, the degree of certainty about where and how it ends must rise, and so it has.

I have updated my (quarterly) chart of house prices as a multiple of average earnings to include the data from December:

UKHPvAvEarnings2.jpg

As you can see, we have had quite a big fall in the last quarter from very slightly under 7 times average earnings at the peak to 5.6 times average earnings. Looking at the chart, I have seen something which indicates to me that not only has my range narrowed, but that while the intention was to err on the side of being conservative, I erred too much in that direction.

One thing many of us in the financial markets have noticed over the years (and decades) is that sharp moves in markets (which are – with the exception of government bond markets - more often than not bear moves, or bull moves in bear markets) tend to take the same speed. In other words, the time needed to fall x% is similar over the overwhelming majority of moves in that market. On the chart (the log-based ones for most markets), that means that the gradient of the move is the same as the gradient of other moves. This earnings-adjusted chart for house prices is likely to be no different:

UKhpivavearnings3.jpg

We can see that the gradient of 90% of the mid 70’s move is the same as that of 90% of the early 90’s move, and that so far the gradient of this move is following a similar pattern. Extrapolating the line for 90% of this move, we can determine when we are likely to reach 90% of the move, depending on where we think house prices are going to versus average earnings.

The conservative view would be that the market will bottom at three times average earnings. If that is the case then:

90% of peak to trough price: 3.385 times average earnings

Duration of 90% of move from now: 3 years

Average earnings adjusted fall between now and early 2012: 15.6% per annum

Average nominal earnings growth p.a.: 2% (1% inflation + 1% average earnings growth – both quite conservative numbers)

Peak to 90% of move fall in nominal prices: 45%

If we then assume that the last 10% of the move takes a further 2.5 years to complete (i.e. to mid 2014) before we reach the bottom, then, using the same number for nominal earnings growth, the overall peak to trough nominal fall in house prices is 48%.

However, given the sheer pain experienced in this deterioration in credit quality and conditions (not least by banks) and the pain to be experienced in this recession and house price fall, as well as the fact that house prices rose so much above fair value before falling, I believe that the market will bottom somewhere below 3 times earnings.

If we now take (a conservative, if you agree that it is going below 3) bottom of 2.5 times earnings, we get the following numbers:

90% of peak to trough price: 2.935 times average earnings

Duration of 90% of move from now: 4 years

Average earnings adjusted fall between now and early 2013: 15% per annum

Average nominal earnings growth p.a.: 2% (1% inflation + 1% average earnings growth – both quite conservative numbers)

Peak to 90% of move fall in nominal prices: 51%

Duration of the fall of the last 10% of the peak to trough move: 3 years (early 2016)

Nominal house price fall from peak to trough: 57%

There we have it – my best guess for house prices – falling between 48% and 57% from the peak and taking between 5 1/12 and 7 years from now to complete.

Edited by Extradry Martini

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About a year ago, I made some very rough predictions here on how far nominal house prices will fall from the 2007 peak before they bottom and recover. These were based on how far I expect/ed house prices to fall versus average earnings (my most confident variable), what inflation and real house prices will be for the period of falling prices, and how long that period would be. The upshot was somewhere between 35% and 50%. As we get closer (note: “closer”, not “close”) to the end of the bear market, the degree of certainty about where and how it ends must rise, and so it has.

I have updated my (quarterly) chart of house prices as a multiple of average earnings to include the data from December:

UKHPvAvEarnings2.jpg

As you can see, we have had quite a big fall in the last quarter from very slightly under 6 times average earnings to 5.6 times average earnings. Looking at the chart, I have seen something which indicates to me that not only has my range narrowed, but that while the intention was to err on the side of being conservative, I erred too much in that direction.

One thing many of us in the financial markets have noticed over the years (and decades) is that sharp moves in markets (which are – with the exception of government bond markets - more often than not bear moves, or bull moves in bear markets) tend to take the same speed. In other words, the time needed to fall x% is similar over the overwhelming majority of moves in that market. On the chart (the log-based ones for most markets), that means that the gradient of the move is the same as the gradient of other moves. This earnings-adjusted chart for house prices is likely to be no different:

UKhpivavearnings3.jpg

We can see that the gradient of 90% of the mid 70’s move is the same as that of 90% of the early 90’s move, and that so far the gradient of this move is following a similar pattern. Extrapolating the line for 90% of this move, we can determine when we are likely to reach 90% of the move, depending on where we think house prices are going to versus average earnings.

The conservative view would be that the market will bottom at three times average earnings. If that is the case then:

90% of peak to trough price: 3.385 times average earnings

Duration of 90% of move from now: 3 years

Average earnings adjusted fall between now and early 2012: 15.6% per annum

Average nominal earnings growth p.a.: 2% (1% inflation + 1% average earnings growth – both quite conservative numbers)

Peak to 90% of move fall in nominal prices: 45%

If we then assume that the last 10% of the move takes a further 2.5 years to complete (i.e. to mid 2014) before we reach the bottom, then, using the same number for nominal earnings growth, the overall peak to trough nominal fall in house prices is 48%.

However, given the sheer pain experienced in this deterioration in credit quality and conditions (not least by banks) and the pain to be experienced in this recession and house price fall, as well as the fact that house prices rose so much above fair value before falling, I believe that the market will bottom somewhere below 3 times earnings.

If we now take (a conservative, if you agree that it is going below 3) bottom of 2.5 times earnings, we get the following numbers:

90% of peak to trough price: 2.935 times average earnings

Duration of 90% of move from now: 4 years

Average earnings adjusted fall between now and early 2013: 15% per annum

Average nominal earnings growth p.a.: 2% (1% inflation + 1% average earnings growth – both quite conservative numbers)

Peak to 90% of move fall in nominal prices: 51%

Duration of the fall of the last 10% of the peak to trough move: 3 years (early 2016)

Nominal house price fall from peak to trough: 57%

There we have it – my best guess for house prices – falling between 48% and 57% from the peak and taking between 5 1/12 and 7 years from now to complete.

A very thorough analysis,however I must take issue with one major point.It is not just price/earnings ratio that affects the market, interest rates must also have a big part to play.In both the previous scenarios rates were in the high single figures,now 4% is a typical rate.Someone renting a house for £500 per month must surely be tempted if a similar property comes along at say £85k making his interest cost little more than half his rent (£3,400 compared to £6000) In my area we are now getting close to these sort of values.

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About a year ago, I made some very rough predictions here on how far nominal house prices will fall from the 2007 peak before they bottom and recover.

As you can see, we have had quite a big fall in the last quarter from very slightly under 6 times average earnings to 5.6 times average earnings.

Nice chart, but I'm afraid your raw data is wrong.

In 2007, the average price to average earning ratio's for the UK as a whole peaked at just under 5.8. In December 2008 it had already dropped to 4.4 times average earnings. I imagine it is lower now.

This would indicate a time compression for the crash much greater than your chart suggests, if in fact you did base it on a decline to date of only a drop from 6 times to 5.6 times......

Edited by HAMISH_MCTAVISH

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Thanks - all interesting.

One point though - what comes through in this chart is that the historical trend and expected range for income multiples WAS broken in the last bubble.

Something fundamental that governs the relationship changed.

So while it's quite likely price/income will fall back into line, there's every possibility it won't. You can't predict with any degree of certainty once current data is outside of the range of historical data you're basing your assumptions on...

Not a bad point, but what took prices above 5 times earnings last time, were enormous twin (and symbiotic) speculative and highly leveraged, bubbles of credit and real estate. For obvious reasons, I think that is a prequisite for prices to remain outside of the band, and I don't see that happening again for a very long time - probably not for a lifetime.

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Great post. 57% is my prediction.

come off it, you just changed your name. ;)

Thanks for this EDM. As per poster above, do you have any thoughts on what might mitigate or excacerbate the drops?

Personally I think that while IRs might help to reduce supply and keep people in their homes, that is offset by the availabilty of credit, and the time it will take to pay off the humungous mortgages people already have, and or for FTBs to save a meaningful deposit that is now required.

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In the manner of an acolyte to a visiting professor;

"Please Sir, thank you for the lecture, how does the work of cynicus economicus bear on your thesis?"

(ducks as professor swipes at student for raising a discredited theory yet again)

http://cynicuseconomicus.blogspot.com/

Note 2: Lord Sidcup has the following question:

If the government is printing money and giving it to the banks, but the banks don't circulate it (won't lend) isn't this money irrelevant in causing inflation?

This is a perfectly reasonable point, which is actually quite challenging. Yes, if the government is lending to the banks and the banks are not lending, it would appear that the money will not have an impact. However, the banks do not sit on that money, but are using it to buy government bonds and other so called 'safe' investments to restore their base of capital.

The government then uses the money lent to it by the banks to lend into the banks, and it appears that the money goes in merry-go-round, albeit with the supply of money steadily inflating. This is why the government needs to print more money, to break this cycle, and create a greater impetus to get money into activity in the economy. They are literally going to deluge the banks with so much liquidity that there will not be enough government debt to buy with the money.

The only trouble with this plan is that so many other countries are also selling huge amounts of debt into world markets. As fast as the government might print money, the amount of debt being issued by governments across the OECD will be able to mop up that money. The bottom line is that the banks do not want to lend to business and consumers because they rightly recognise that there are considerable risks in doing so. This is why the government is considering measures to 'force'/encourage the banks to lend into the UK economy, such as reductions in capital adequacy requirements and so forth.

As I have pointed out many times, the problem with government borrowing is that it crowds out lending to the private sector.

In this circumstance, how will the money printing lead to inflation? The printed money is still going to be used but, instead of being used by business and consumers, it will now go through the intermediary of the government, as the printed money eventually ends up back on the government's books through their borrowing. This creates a time lag, as the government must find ways of using that money in various guises of 'stimuli'. There is also a time lag as the money goes through the lending / borrowing merry-go-round.

Within this rather odd scenario is a possibility that the banks in the UK will start to worry about the solvency of the government, and will therefore stop lending to the government. They might instead use the borrowed money only to finance debt of other governments. This is, in principle, possible, but is also highly unlikely. The banks are now effectively clients of the state, so I believe that they will be expected/forced to support the state with continued lending. I do not know this, but I think it is a reasonable assumption.

What we have in total is a situation where some of the printed money will be returned to the government, and some of the printed money will be used to finance the governments of other countries, and some will eventually find its way into private lending in the UK. In all cases, the money will appear in the market place.

If, for example, the banks use money to finance borrowing of overseas governments, this is a net outflow of currency, which will further weaken the £GB. If the money remains in the UK, it will eventually reach the economy in the form of loan guarantees, and various other government stimuli measures. In all cases, the money does eventually reach the market. The important point in all of this is that there is a significant buffer in all of this, which is the ability of the government to actually utilise the money such that it reaches both businesses and consumers in the UK.

The most disturbing part of this scenario is the impact of the government which acts as a buffer for some of the money that is created. In acting as a buffer it is possible in principle that the effects of the increase in supply will not be immediately apparent, encouraging a belief that the government can 'get away' with printing money, thereby further encouraging an acceleration of the speed of the printing presses.

What can not be hidden is that there will eventually be an increase in the quantity of £GB in the market. As I have often stressed, printing money just transfers the value of the existing money to the new money, which dilutes the value of money. This is inflation.

However, I do not think that that people are quite foolish enough to believe that printing money can be a solution to the underlying problems of the UK. This is why I believe that the £GB will collapse sooner rather than later. I do not believe that holders of the £GB will hold on to the currency, as they will start to price in the effects of both the underlying weakness of the £GB and the impact of money printing. At that point, there will be inflationary surges due to substantial increases in the costs of imports.

This brings me to another point. In my original post I pointed out that a collapse in the currency would result in hyper-inflation. I should clarify this, as I have noted comments (not made on this blog) which have imagined that the moment the currency collapses is the moment at which hyper-inflation appears. This was not my intended meaning. There will be a time lag, as existing contracts are fulfilled and so forth. Some products will see price inflation very quickly, such as imported foodstuffs, whilst other products may take a while for prices to inflate. However, the process will still be surprisingly rapid, just not immediate.

It seems that a very short question has demanded a very long answer. It is not a simple answer but I hope I have managed to be clear and consistent. Please let me know if I have been either unclear, or missed any key points.

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What average earnings figure are you using? I would take issue with 4.4 by 2008.

The ones the media were reporting two weeks ago. From Nationwide/Halifax price reports I believe, and available from the link on this site.

Also fits almost exactly with the widely reported 20% ish drop in average prices so far.

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A very thorough analysis,however I must take issue with one major point.It is not just price/earnings ratio that affects the market, interest rates must also have a big part to play.In both the previous scenarios rates were in the high single figures,now 4% is a typical rate.Someone renting a house for £500 per month must surely be tempted if a similar property comes along at say £85k making his interest cost little more than half his rent (£3,400 compared to £6000) In my area we are now getting close to these sort of values.

No, interest rates play a very small part over the long term, and nominal interest rates an even smaller part. Mortgages are long term - rate cycles are not, and this is what is reflected in the chart.

On top of that, it is not the nominal amount of interest over the life of the mortgage which you are paying which determines the cost of the mortgage, nor even the real rate of interest, but the real rate as a proportion of the nominal rate. Look at this table:

Mortgagevsalary2.jpg

In the first case the buyer is buying a house worth 100k, is borrowing money at 10% and his salary is increasing (mostly because of inflation) at 8%. In the second case, the buyer is borrowing at 5% and his salary increases by 3% each year. In both cases the monthly mortgage cost is the same, but the second home-owner spends more than twice as much as a proportion of his salary than the first borrower, even though the price of his house is only 55% more and the real rate of interest he is paying is the same.

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The ones the media were reporting two weeks ago. From Nationwide/Halifax price reports I believe, and available from the link on this site.

Also fits almost exactly with the widely reported 20% ish drop in average prices so far.

Is this the 34000-ish "average household income"?

If so, I am not sure that you would then expect the bottom to be at 3, more like 2.

The results are probably the same.

Can I start my Michael Mann hand waving now? ;)

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Nice chart, but I'm afraid your raw data is wrong.

In 2007, the average price to average earning ratio's for the UK as a whole peaked at just under 5.8. In December 2008 it had already dropped to 4.4 times average earnings. I imagine it is lower now.

This would indicate a time compression for the crash much greater than your chart suggests, if in fact you did base it on a decline to date of only a drop from 6 times to 5.6 times......

Hamish, Extradry

Thank you both for your contributions. I would find it helpful if you could both give citations for the figures; I tend to have (probably too much) faith in numbers and it should be fairly straightforward to reconcile why one source says the price:earnings ratio is 6.5 or 5.5.

SB

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Is this the 34000-ish "average household income"?

If so, I am not sure that you would then expect the bottom to be at 3, more like 2.

The results are probably the same.

Can I start my Michael Mann hand waving now? ;)

Either way his data is inconsistant.

A fall of 20% in house price averages from peak has already occurred. Nobody disputes this.

Our start point is the same. (5.8 for me, "slightly less than 6" for him)

A fall of 20% from peak would not move the affordability from 6.0 to 5.4. That would be a 10% fall.

The data is wrong. End of story.

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Thats a very lengthy analysis, which comes to the same conclusion of the much simpler principle:

As there are only mortgages available that are between 3 and 5 x average salary, then house prices will fall to within this range in order that there are buyers available. The average salary is £25k. Therefore the average house price will be in the range of £75k - £125k.

The slope of the line in the graph shows the rate at which the price is changing, which if you follow historical trends and apply to the rate of change can be predicted to bottom out in 2012.

Hope thats useful for the less analayticaly minded readers.

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Can I ask have you factored in decreasing wages?

If the average wage starts to fall then house prices will have further to fall won't they?

The other problem is that this crash maybe nothing like previous house price crashes, but it appears that a 50% fall seems to the best outcome of this mess.

Good post.

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Nice chart, but I'm afraid your raw data is wrong.

In 2007, the average price to average earning ratio's for the UK as a whole peaked at just under 5.8. In December 2008 it had already dropped to 4.4 times average earnings. I imagine it is lower now.

This would indicate a time compression for the crash much greater than your chart suggests, if in fact you did base it on a decline to date of only a drop from 6 times to 5.6 times......

Raw data:

Nationwide data "UK Quarterly Indices Post 91" Q2 07 Average house price = £181,810, Q4 08 Average house prices £156,828

ONS "AEI: main industrial sectors"/"Whole economy": Q2 07 index at 130.7 Q4 08 Index at 136.6, both v. 100 in 2000

I have the average earnings for 2000 at 20,320, meaning that average incomes were as follows:

Q2 07 26,558

Q4 08 27,757

Meaining that income multiples were as follows:

Q2 07 6.85

Q4 08 5.64

I would suggest you check your facts before writing something like that.

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Either way his data is inconsistant.

A fall of 20% in house price averages from peak has already occurred. Nobody disputes this.

Our start point is the same. (5.8 for me, "slightly less than 6" for him)

A fall of 20% from peak would not move the affordability from 6.0 to 5.4. That would be a 10% fall.

The data is wrong. End of story.

No I wrote that wrong (now corrected). I meant "slightly less than 7" - as the chart as the chart quite obviously shows. It is your data which is wrong, as I have proved above.

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Hamish, Extradry

Thank you both for your contributions. I would find it helpful if you could both give citations for the figures; I tend to have (probably too much) faith in numbers and it should be fairly straightforward to reconcile why one source says the price:earnings ratio is 6.5 or 5.5.

SB

See above. Both sets of data downloadable online. The other poster simply did not check his facts - a bit of a foolish mistake if you are going to accuse people of using bad data, but a mistake nonetheless I'm sure.

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Can I ask have you factored in decreasing wages?

If the average wage starts to fall then house prices will have further to fall won't they?

Correct.

Apart from anything else, if we have less money we can only buy cheaper real estate.

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One point though - what comes through in this chart is that the historical trend and expected range for income multiples WAS broken in the last bubble.

Something fundamental that governs the relationship changed.

I think it's no coincidence that we see a near vertical trajectory starting from 2001 onwards

Post 9/11, a deadly combination of negative real interest rates and financial alchemy combined to make a 'perfect storm' for debt inflation.

But IMO the latter is due to Sabanes Oxley rather than 9/11, as accounting tricks were swept under the carpet, off balance sheet. The two unrelated events just happend to occur around the same time

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Thats a very lengthy analysis, which comes to the same conclusion of the much simpler principle:

As there are only mortgages available that are between 3 and 5 x average salary, then house prices will fall to within this range in order that there are buyers available. The average salary is £25k. Therefore the average house price will be in the range of £75k - £125k.

The slope of the line in the graph shows the rate at which the price is changing, which if you follow historical trends and apply to the rate of change can be predicted to bottom out in 2012.

Hope thats useful for the less analayticaly minded readers.

Not bad. I'd add that if you are talking about 3 - 5 times from a mortgage perspective, it reflects banks past love/hate of mortgage credit risk. It went nearly to 7 and I believe that it will fall to below 3. But I think it also refelects broader public sentiment towards housing, and bankers are members of the public just as much as any of us.

Edited by Extradry Martini

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Hamish, Extradry

Thank you both for your contributions. I would find it helpful if you could both give citations for the figures; I tend to have (probably too much) faith in numbers and it should be fairly straightforward to reconcile why one source says the price:earnings ratio is 6.5 or 5.5.

SB

Links to the raw data are available on the front page of this website.

Or this one to one of many media reports....

http://business.scotsman.com/personal-fina...-hit.4841356.jp

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  • 284 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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