And another article also taken from the Sunday Times [Januay 03 edition ]
Your boom is nigh: the great housing catastrophe
andrew oswald
Sell your home by May. Then go away. Over the next two years there is going to be blood on estate agents? carpets from Thurso to Torquay.
The outlook is now extremely serious for Britain?s housing market ? contrary to the optimistic forecast by the Nationwide building society yesterday that most of us can expect at least double-digit price increases this year, after a 25 per cent boom in 2002.
I side with the pessimists and expect to see a 30 per cent fall in prices between the middle of 2003 and the end of 2005. So, if you can do it without ruining your personal life, my professional advice is that you should put your home up for sale as soon as possible.
I am not persuaded that even in the long run homes will offer as good a return as they have during my lifetime. Firstly, the income tax advantages of owning bricks and mortar are lower than they have been for decades, and mortgage interest relief will never return.
Second, the birth rate is falling. On current estimates the British population will start to shrink sometime around the year 2025, which will be bad news for the demand for homes. Third, as more parents allow their children to have sexual partners living in the family home, the incentive, especially for young males, to flit the comfort of the nest for separate accommodation will steadily drop.
Fourth, Gordon Brown?s stamp duty tax on house purchase (now 4 per cent of the value of any house costing more than £500,000) will encourage people to stay put and live more densely within the same housing space. Fifth, it is only a matter of time before more of the green belt is overcome by the harsh laws of demand and supply in the South East: inevitably, more houses will have to be built within that region.
Consider the intellectual case for such new year gloom. We have been brought up to believe that sustained falls in the price of houses are impossible. Tell that, however, to those who live in Hong Kong, where prices fell by 65 per cent. Or go to the library and examine the wave-like graphs of British history. Once inflation is subtracted (so that we look at ?real? prices), one finds that by 1977 the value of homes stood 30 per cent below their peak in the early years of that decade. At the end of 1995 the real value of homes was 40 per cent below the top of the market reached in the early 1990s. I have looked at current data, and I expect the Great Crash of 2003-5 to be just as severe.
One useful piece of formal economics has percolated into public debate. The best indicator of what will happen in the housing market is historically an arithmetical formula, namely, the ratio of house prices to incomes. In Great Britain, the long-run ratio of the average price of a home to the typical person?s earnings is approximately four. In other words, if a representative Briton earns £25,000 a year, then house prices are happily in equilibrium when they average about £100,000. That sustainable ratio tends to be a little higher in London and the South East, and a bit lower elsewhere, but the ratio of four is the right broad-brush number.
Unfortunately, we are now considerably above a safe ratio. House prices have reached a multiple of five times average earnings. Danger signals are not merely flashing but are on the verge of fusing. Low interest rates have never saved us in the past and they won?t save us this time.
And be in no doubt, it will hurt. In earlier times, inflation and rising pay levels took away some of the pain. What matters in a red-hot property boom is to get the ratio of house prices to earnings down from the stratosphere. When pay was rising fast, the ratio fell. But this time around, with inflation at only a couple of per cent, almost all the unpleasantness is going to have to come through drops in the price of our homes.
Take my tip: move into rented accommodation in time for summer sunshine. After that, put as much money as you dare into the stock market. Alternatively, one could take the view, as with a pension portfolio, that housing will go up and go down, and that one should grit one?s teeth and stay fully invested. Yet the argument against doing that is a good one: if I live in a £300,000 house or flat and if I could get my timing perfect ? in and out of renting ? I might be able to save nearly £100,000, tax free. That kind of figure concentrates the mind.
As in most markets, when things get overvalued, a decline in prices does not merely return us to the long-run average. Things overshoot. In other words, when people start selling, they get carried away, and prices go too far down. The same happens in the upwards direction, of course. Excessive herd movement happens on the way up and the way down.
Take, for example, the stock market. The value of shares is dictated, essentially, by people?s confidence in the future. More precisely, the price that traders are willing to pay for a share such as Tesco or Barclays is fixed by their gut feeling about the degree of prosperity to come in the British economy. Share prices tell us about confidence.
The same has to be true in the housing market. Both shares and homes are assets. They are worth something now because they will produce a stream of returns in the future.
This takes us to a point that seems not to have been made in public debate. It makes no sense for the stock market to be valued below its long-run trend while housing is valued way above its long-run trend. Because both are assets, that cannot be sustained. Either people are confident about the future, in which case both houses and shares should be worth a lot, or they are not confident, in which case the prices of both shares and houses ought to be low.
But what of the idea that experts fix share prices, while amateurs fix house prices? Perhaps this means, it might be argued, that the housing and stock markets can take separate paths. No: even amateurs eventually catch on.
I believe that house prices will continue to rise about 5 per cent or a little more until summer 2003. Then I expect them to fall by almost one third. One way to understand this is to work out the numbers and study history. Another is to use pure logic. Both, however, point to the same conclusion. This market looks impossibly stretched.
Why? The over valuation of house prices is being driven by low interest rates and a lack of logic by purchasers. Buyers have mistaken low interest rates as a sign that houses are, in some sense, cheap. Regrettably, that is an illusion.
Just because my mortgage repayments today are lower than they would be in a situation of high inflation and high interest rates does not mean, in a true sense, that my home is now less expensive. A £30,000 Saab is not cheaper in a world where interest rates are low, nor dearer in a world where interest rates are high. The price is the price.
It is the same with houses. Indeed, the appropriate interest rate to look at, if any, is the real cost of borrowing. This is the interest rate compared to the inflation rate. Despite borrowers? perceptions, that interest rate is not especially low at the moment.
The crash will probably start something like this:
In the spring of this year it will begin to be generally recognised that house prices have stopped rising. Purchasers will cease to be enthusiastic. Many with buy-to-let properties will begin to sell. House prices will shudder. Then, by late summer, I see confidence in housing ebbing more substantially. Prices, even outside slowing London, will crumble. Headlines will appear: house prices fell 4 per cent last year, 8 per cent last year, perhaps 12 per cent. Panic will thus set in.
Sadly, there is really nothing that can now be done. In the long run, we must think hard about how to make the British housing market work more sensibly. In the short run, the message is simpler. Sell up now.
Topic: Mortgages (Read 3249 times)