Buyers Don’t Care About House Prices

[Mr Punter]

Although lots of people on this forum focus on house price and analyse things like house prices to earnings ratio and historical house price data, it is my contention that buyers don’t care about house prices, just whether they think they can afford it.

While economic factors do influence the decision to buy or sell, the primary force that sets the price is affordability, followed by the secondary force of sentiment (fear / greed).

Very few purchasers will save enough to buy a house outright and so the decision on affordability is mostly related to the loan cost. I suggest that even if the price for an average house were to increase to £400k and it was available with finance at 0.5% fixed interest only there would be plenty of takers. At £2000 a year interest, most would be tempted.

The chart below plots the inflation adjusted cost of loan servicing on the average house price against the (famous) Nationwide house price chart. The loan payments are based on 80% of the prevailing average house price, 2% over base, payment over 25 years. I have entered the current base at 2.5% because 4.5% is more typical current deals. The chart also shows a trendline for loan costs with error bars at +-20%. Too much time spent north of the upper line means real discomfort, while time spent south of the line tends to be the fuel for the next bubble.

Note the contrast between the 1989 house price peak, with loan costs rising to 86% above trend and remaining high for 2 years to the 2007 peak, where loan costs were 52% above trend for but fell to trend levels within 12 months. In the early 90s property was being repossessed not primarily because of unemployment but because of high interest rates. This time round the quick cut to low interest rates mean that the flood of early 90s style forced sellers is not going to happen.

While I can see that stricter lending may have some effect on demand, I feel that there are enough people who meet the stricter criteria to take up the limited supply. If we see a fall of more than 15% over the next five years I will be very surprised.

[yellerkat]

I nominate this post for "Silliest of 2009 to Date".

[dances with sheeple]

Although lots of people on this forum focus on house price and analyse things like house prices to earnings ratio and historical house price data, it is my contention that buyers don’t care about house prices, just whether they think they can afford it.

While economic factors do influence the decision to buy or sell, the primary force that sets the price is affordability, followed by the secondary force of sentiment (fear / greed).

Very few purchasers will save enough to buy a house outright and so the decision on affordability is mostly related to the loan cost. I suggest that even if the price for an average house were to increase to £400k and it was available with finance at 0.5% fixed interest only there would be plenty of takers. At £2000 a year interest, most would be tempted.

The chart below plots the inflation adjusted cost of loan servicing on the average house price against the (famous) Nationwide house price chart. The loan payments are based on 80% of the prevailing average house price, 2% over base, payment over 25 years. I have entered the current base at 2.5% because 4.5% is more typical current deals. The chart also shows a trendline for loan costs with error bars at +-20%. Too much time spent north of the upper line means real discomfort, while time spent south of the line tends to be the fuel for the next bubble.

Note the contrast between the 1989 house price peak, with loan costs rising to 86% above trend and remaining high for 2 years to the 2007 peak, where loan costs were 52% above trend for but fell to trend levels within 12 months. In the early 90s property was being repossessed not primarily because of unemployment but because of high interest rates. This time round the quick cut to low interest rates mean that the flood of early 90s style forced sellers is not going to happen.

While I can see that stricter lending may have some effect on demand, I feel that there are enough people who meet the stricter criteria to take up the limited supply. If we see a fall of more than 15% over the next five years I will be very surprised.

So will I. We should see that fall over the next year.

[Bloo Loo]

Its true people look at the monthly cost.

thats why they are doomed.

they went IO..they went share with a friend

they saved nothing....they got others to pay the deposit.

affordability criteria is DEATH to the financial system......

[Executive Sadman]

And all it took for millions of them to default on payments was 5% interest rates. That is NOT a sustainable situation.

Most house buyers might be idiots, at some point though lenders will have no choice but to limit lending.

[Red Baron]

I think buyers do care about prices; the affordability argument is VI nonsense. We have seen a 20% drop in prices with probably another 20% to come off prices as we begin the next leg down. That should be a matter of concern for anyone with common sense.

[Timm]

I nominate this post for "Silliest of 2009 to Date".

Oh. I thought it was rather good.

In fact, I had been thinking of doing something similar myself.

I don't agree with the conclusion though, as it assumes current affordability will remain static. With inflation coming: it won't.

[Laura]

Yet another one who must think Sterling is invincible & denies QE .

[Mr Punter]

Oh. I thought it was rather good.

In fact, I had been thinking of doing something similar myself.

I don't agree with the conclusion though, as it assumes current affordability will remain static. With inflation coming: it won't.

Interest rates have traditionally been about inflation + 2%. If inflation goes to 8% and IRs at 10%, the HPC predictions will come true.

[babesagainstmachines]

Interest rates have traditionally been about inflation + 2%. If inflation goes to 8% and IRs at 10%, the HPC predictions will come true.

Did you miss the first leg of the crash? You know, the one that knocked 30k off the average house price...

[Harry Sacks]

Although lots of people on this forum focus on house price and analyse things like house prices to earnings ratio and historical house price data, it is my contention that buyers don’t care about house prices, just whether they think they can afford it.

While economic factors do influence the decision to buy or sell, the primary force that sets the price is affordability, followed by the secondary force of sentiment (fear / greed).

Sad but true. There has been a cultural change spanning three generations. People are incapable of joining the dots to see the big picture.

[Phil S]

A 15% drop in 5 years would be about 25% in real terms (assuming annual inflation at 2%). Quite a drop!

[AteMoose]

Sensible post

The mortgage market and the deals available control houseprices

It has been more expensive in the past to buy a property (costs more in your pay packet each month), and low IRs has reduced the pain. People think about the here and now, they don't plan further than the end of there noses. Just look at shared equity deals for the evidence.

If inflation rises the costs go up for a while but the inflationary effects will eventually make property more affordable.

Edited September 3, 2009 by moosetea

[MississippiJohnHurt]

It's the biggest financial committment people ever make, spread over 25 years, and they only think about whether they can afford the payments in the first month? Depressingly you're probably right. That doesn't mean it's a sensible calculation though, or that it would lead to a sustainable housing market. It just means there's loads of numpties who'd get repossessed very quickly if rates got to 7, 8, 9% (think they were this high in very recent memory, early 90s...)

It just makes me think that people need to be saved from themselves. 25%+ deposit is one way a lender might attempt to do so cos at current prices, that's going to hard to achieve if you're say trying to trade from a flat bought in last 5 years to a house in same area. Notable that really low rates are only available on big deposit mortgages, the rate on 10% deposit loans tends to be 6%+ doesn't it?

[mbga9pgf]

Sad but true. There has been a cultural change spanning three generations. People are incapable of joining the dots to see the big picture.

I think the OP has a valid point. What he needs to factor in though, is what happens next when rates go back up with hideous levels of unemployment, or rates stay low and those on mortgage payment support run off the end of those schemes, onto variable rates 3-5% above base with no income to make mortgage payments?

Queue response: rates to stay low. Well, yes, but rates will only stay low if we have a kacked out economy still. Which = lots of unemployment still, which means as soon as government assistance fades away, or they run out of the 2 year breather that the schemes give them, they will be in sh*t street and looking to sell their homes to downsize asap.

Option 2, Inflation = much higher rates, possibly as high as 6-8%, meaning your affordability graph looks like it will peak at a much higher level than the 90s crash.

Either way, all that has happened is that the buck has been passed to the next government (the tories) which effectively means this is a waiting game for the Bears. House prices simply arent going to recover for a very long time, even if we have sustained near-0 rates due to the drag caused by unemployment.

[the flying pig]

Omitting any measure of earnings makes it worthless.

The even dafter thing about the post is the stupid title "buyers don't care about house prices" - e.g. does the OP think that the huge peak in borrowing costs in 2007 was caused by anything other than, er, high house prices? more generally, the navy and yellow lines follow each other almost perfectly. all of the significant falls in real mortgage costs have been brought about partly or wholly by, er, falls in real house prices.

The concept of a 'real' (i.e. CPI or RPI) house price is a nonsense, the idea that there's a meaningful 'trend' in this measure, other than one caused by real wage growth which of course varies somewhat over time, is silllier.

There's a fair bit of truth in the oft-made VI claim that omitting borrowing costs from traditional earnings ratios risks leading to misleading results, but to substitute earnings data with borrowing costs is just daft. The sensible thing to do is use a measure that includes both wages and borrowing costs. I believe that the daily telegraph sponsors some kind of affordability index that does just that?

Edited September 3, 2009 by the flying pig

[blankster]

People care about prices to some extent - like if there are two similar houses, they'd tend to choose the cheapest.

But the asking price is only part of the story - the interest rate and mortgage deal is a major part of the total cost of buying the house.

We own our house outright. I tend to think of its value not in terms of £££ so much as its value relative to the property market.

[roy?]

I agree with a lot of what the poster states. Ultimately, property price fluctuations will be contingent upon affordability and sentiment.

It’s interesting that people tend to get offended when there are posts such as these. Unless interest rates increase to 7-8%, no-one is going to sell. Only a massive volume of distressed sellers entering the marketplace will serve to drive down prices.

The question is, will rates rise before property prices?

[Bloo Loo]

I think the OP has a valid point. What he needs to factor in though, is what happens next when rates go back up with hideous levels of unemployment, or rates stay low and those on mortgage payment support run off the end of those schemes, onto variable rates 3-5% above base with no income to make mortgage payments?

Queue response: rates to stay low. Well, yes, but rates will only stay low if we have a kacked out economy still. Which = lots of unemployment still, which means as soon as government assistance fades away, or they run out of the 2 year breather that the schemes give them, they will be in sh*t street and looking to sell their homes to downsize asap.

Option 2, Inflation = much higher rates, possibly as high as 6-8%, meaning your affordability graph looks like it will peak at a much higher level than the 90s crash.

Either way, all that has happened is that the buck has been passed to the next government (the tories) which effectively means this is a waiting game for the Bears. House prices simply arent going to recover for a very long time, even if we have sustained near-0 rates due to the drag caused by unemployment.

course he has a point....the whole OPtion ARM and sub prime DEATH to the financial SYSTEM, was caused by bankers selling huge deals to people who could ( many couldnt) afford the teaser rate...the get out was that the house could be sold and nothing lost by buyer or bank, or another new loan rolled over with a fresh teaser.

worked well, produced a huge bubble, till it didnt.

Affordability, whilst important, is just ONE of the criteria a lender should use...not the MAIN one.

[Bloo Loo]

I agree with a lot of what the poster states. Ultimately, property price fluctuations will be contingent upon affordability and sentiment.

It’s interesting that people tend to get offended when there are posts such as these. Unless interest rates increase to 7-8%, no-one is going to sell. Only a massive volume of distressed sellers entering the marketplace will serve to drive down prices.

The question is, will rates rise before property prices?

rates are already at 5%+ for good deposits, and way above for 10% deposits.

[mfp123]

Although lots of people on this forum focus on house price and analyse things like house prices to earnings ratio and historical house price data, it is my contention that buyers don’t care about house prices, just whether they think they can afford it.

While economic factors do influence the decision to buy or sell, the primary force that sets the price is affordability, followed by the secondary force of sentiment (fear / greed).

Very few purchasers will save enough to buy a house outright and so the decision on affordability is mostly related to the loan cost. I suggest that even if the price for an average house were to increase to £400k and it was available with finance at 0.5% fixed interest only there would be plenty of takers. At £2000 a year interest, most would be tempted.

The chart below plots the inflation adjusted cost of loan servicing on the average house price against the (famous) Nationwide house price chart. The loan payments are based on 80% of the prevailing average house price, 2% over base, payment over 25 years. I have entered the current base at 2.5% because 4.5% is more typical current deals. The chart also shows a trendline for loan costs with error bars at +-20%. Too much time spent north of the upper line means real discomfort, while time spent south of the line tends to be the fuel for the next bubble.

Note the contrast between the 1989 house price peak, with loan costs rising to 86% above trend and remaining high for 2 years to the 2007 peak, where loan costs were 52% above trend for but fell to trend levels within 12 months. In the early 90s property was being repossessed not primarily because of unemployment but because of high interest rates. This time round the quick cut to low interest rates mean that the flood of early 90s style forced sellers is not going to happen.

While I can see that stricter lending may have some effect on demand, I feel that there are enough people who meet the stricter criteria to take up the limited supply. If we see a fall of more than 15% over the next five years I will be very surprised.

the price of houses is not determined by the buyers but the mortgage market.

who decides how much you can borrow?

hint - its not you.

[ARIMA]

The OP is correct in that interest rates (read CPI) will decide the outcome over the next few years. So much housing debt is linked to the base rate in the UK, that a rise back above 4% will start to turn the screw...

Edited September 3, 2009 by GARCH

[winkie]

Its true people look at the monthly cost.

thats why they are doomed.

they went IO..they went share with a friend

they saved nothing....they got others to pay the deposit.

affordability criteria is DEATH to the financial system......

Sooo true, on the whole there have been too many that borrowed any amount they could lay their hands on to secure what they wanted, now today...instant gratification and the thought of geting rich quick overcame common sense and future pain. The good thing about it all is the free money from past property growth, together with free money without proven affordability will not be coming back any time soon...any debt or promise to pay will subject to ability to pay.

Edited September 3, 2009 by winkie

[winkie]

Tell me I am right...or wrong.

Debt is a means to an end.

[Angelfish]

the price of houses is not determined by the buyers but the mortgage market.

who decides how much you can borrow?

hint - its not you.

Correct, as people generally don't have the money up front to buy a house, they have to borrow from a bank.

The banks job "should" be to lend as much money out to people as possible at a level which they can just about afford to pay it back, without defaulting.

The customer thinks "How much can I afford each month?"

The bank thinks "How much can this person afford each month without defaulting?"

Sure they could let a FEW people default, reposess the houses and then sell them on (probably not making as much money if the mortgage was completely paid off). This won't affect the market much. LOTS of people defaulting is bad as it floods the market so prices fall.

Unfortunately banks have become supermarkets "selling you products" by "advisors" who know they need to get the commission whilst they can, because they'll be sacked next month if they don't reach targets.