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Housing Fair Value?

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http://www.moneymovesmarkets.com/journal/2...o-a-trough.html

We have to challenge ourselves (no doubt Sibley et al., will be along shortly telling us all how GREAT this news is)...

(see link for graphs)

Are UK house prices close to a trough?

Posted on Tuesday, May 26, 2009 at 01:41PM by Simon Ward | 3 Comments

UK house prices are no longer expensive relative to a measure of "fair value" based on rents. Prices fell significantly below fair value during the major house price busts in the 1970s and 1990s but a big undershoot is unlikely in the current downturn because low interest rates will limit forced selling.

The notion that housing is no longer overvalued is controversial because the house price to income ratio remains far above its average since 1965 – see first chart. This average, however, is unlikely to be a good guide to fair value because the ratio has trended higher over time, reflecting factors such as improving quality, the pressure of an expanding population on constrained supply and a high income elasticity of demand for housing.

An alternative approach is to use rents rather than income as the basis of comparison. Rents already incorporate fundamental influences on housing demand and supply. People need to live somewhere – the choice is between buying your own home or renting, not between spending money on housing or retaining income for other purposes.

An economy-wide rental yield can be calculated from national accounts data by dividing the sum of actual rental payments and imputed rents of owner-occupiers by the value of the housing stock – second chart. The yield averaged 3.6% between 1965 and 2007. This seems low but the measure includes subsidised social housing and takes account of vacant properties.

The housing boom pushed the rental yield down to 2.8% at the end of 2007, suggesting that prices were then overvalued by about 29%, based on the 3.6% long-run average. The Halifax index has fallen by 21% since December 2007, while rents had grown 6% by the fourth quarter of last year. These changes imply a current yield of about 3.8%, consistent with small undervaluation.

The rental yield rose well above the 3.6% long-run average during prior housing busts. If the overshoot in the current downturn were to equal the undershoot during the boom, the yield would rise to 4.4%. This would be consistent with a further fall in prices of about 14%, assuming unchanged rents. A decline of this order is widely expected.

Such a scenario, however, is probably too pessimistic. A key difference from prior busts is the low level of mortgage interest rates, which is allowing many struggling borrowers to continue to service their loans. The Council of Mortgage Lenders last week reported that repossessions and arrears cases rose by less than feared in the first quarter. The CML intends to revise down its earlier forecast of 75,000 repossessions in 2009.

With less distressed selling, downward pressure on prices from rising supply is much smaller than in prior downturns. According to the Royal Institute of Chartered Surveyors, the number of unsold homes on the books of the average estate agent stood at 69 in April – far below peaks of 166 and 196 in the last two major housing downturns. Meanwhile, buyer enquiries have picked up recently.

Translating buyer interest into transactions depends critically on mortgage availability. The last Bank of England credit conditions survey reported tighter mortgage supply in early 2009 but expectations of an improvement in the spring. Signs of a stabilisation of prices could have a self-reinforcing effect by encouraging lenders to reduce current high deposit requirements, designed partly to protect against negative equity.

Of course, if house prices bottom at a smaller discount to fair value than in previous downturns, this also implies less scope for a significant recovery over the medium term. Moreover, an increase in supply may have been postponed rather than cancelled – "zombie" borrowers will have their life support turned off once the MPC starts raising interest rates.

TRANSLATION:

The market price of housing would have dropped much further. However, government (or BoE) intervention prevented this. Taxes will have to rise in future to keep the feckless in their homes today. Remember, be HAPPY about this. It's your duty to pay more for housing. Anyone questioning this is possibly a redski...

Reader Comments (3)

Interesting,however rental yields are now beginning to fall in response to lower demand. Moreover, forced sales are unlikely when normal severance terms give 6 months salary and interest rates are at 300 year lows. When (not if!) interest rates have to rise, the impact of higher mortgage rates and continuing unemployment will push a lot of home owners into sales they might wish to have made now.It will also trigger sales from the rental sector as the gap between mortgage payment rates and rental yield narrows to zero and then turns negative.Cycles mean just that and there is no reason why the down period should be shorter or shallower than the uptick.

May 27, 2009 | Drew

I am more inclined to agree with Drew - not least as a) unemployment is still rampant, accelerating, and IMHO not likely to abate for months yet, and it's traditionally a good proxy for property, B) many deals from 2 years ago are about to come to an end and the borrowers will, in the main, be ADVERSELY affected in the current market and c) I am far from convinced that the banks/lenders have the appetite or, in some cases still, the funds to lend!

May 28, 2009 | SJG

Thanks for the comments. SJG: unemployment will rise further but the rate of increase may have peaked - the monthly change in the claimant count was 137k in February, 66k in March and 57k in April. On your refinancing point, the average quoted two-year fixed rate (75% LTV) was 5.7% in May 2007 according to the Bank of England, above the current average standard variable rate of 4.06% (March data).

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rents: elastic prices

house prices: elastic prices.

neither is founded in solidity. neither can be used to calculate the other.

You need a grounding....where are the prices above derived from? well, wages, without wages, there is no rent, there are no house prices.

so to work out affordability on an elastic is just silly.

as wages fall and unemployment rises, where are rents going? where are house prices going?

stupid maths for journos.

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"An economy-wide rental yield can be calculated from national accounts data by dividing the sum of actual rental payments and imputed rents of owner-occupiers by the value of the housing stock – second chart. The yield averaged 3.6% between 1965 and 2007. This seems low but the measure includes subsidised social housing and takes account of vacant properties."

This seems low = this seems wrong. What was the average interest rate over the same period?

I wonder how many owner occupiers could afford the imputed rent in the last few years.

And how did they resolve the circularity? (Imputing rents, presumably using an assumed yield, to calculate average yield.) Someone please enlighten me.

In any case, prices and rents are set at the margin, not on the entire stock at once. Or is the UK in play?

Oh, and then there's sentiment.

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Housing fair value well lets do the sums

£24k - MIRAS * 3.5=£70k

Is the average price £70 or is someone talking a load of rubish or wot.

Thorw in all the tax rises we will see for all that bankster money and petrol hiting $100 pp and i would argue £70k is being generious.

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