Keen to buy a house but not if they are likely to bottom within the next year 18mths. I will wait.
Shaky foundations
The recovery in British house prices is built on sand
Feb 11th 2010 | From The Economist print edition
Illustration by S. Kambayashi
FALLING house prices were the trigger for the financial crisis, so it should be good news that they have stabilised, in America and Britain at least. But the way they have stabilised still presents a bit of a puzzle. As Dhaval Joshi, an analyst at RAB Capital, points out, the fall in British economic output was greater and the subsequent recovery less vigorous than in America. But British house prices are up by 10% from their lows, while American homes are only 3% above the bottom despite energetic government support, including a homebuyers? tax credit that has been extended until April.
Mr Joshi sees the answer to this divergence in terms of supply. Between 2002 and 2006 American builders constructed 12m new homes while only 7m new households were formed. American homeowners are also much more likely to walk away from their debts because many mortgages are ?non-recourse?, meaning that lenders cannot come after borrowers? other assets. As a result, repossessions are much higher in America than in Britain: Capital Economics says that some 5m foreclosed homes will come onto the market over the next two years.
In Britain, in contrast, the Council of Mortgage Lenders (CML) thinks that fewer than 50,000 homes were repossessed last year. And planning laws mean that the growth of new housing supply has been very limited. Throughout the past decade British household formation outpaced the construction of new homes. Thanks in part to lower unemployment rates than America, British homeowners are not being forced to offload their houses at fire-sale prices. So there has been steady upward pressure on those few properties on offer.
Whatever the reasons, the differential nature of the rebound has opened a big valuation gap between the countries. Relative to incomes, American house prices are below their post-1968 average. They also look cheap relative to GDP per head.
In Britain, house prices are overvalued. This shows up most starkly in the figures for first-time buyers, the plankton of the housing food-chain. Figures from the Nationwide Building Society show that the ratio of house prices to earnings for such buyers peaked at 5.4 in 2007. The ratio then fell as the housing market deteriorated, reaching 4.1 in the first quarter of 2009 before rebounding to 4.4 at the end of last year. But the record low for the ratio was 2.1, which was reached back in 1995. Indeed, the ratio did not even fall back to its long-term average of 3.3 (the data was first compiled in 1983).
Why, then, is there so much talk of affordability in the British market? The main reason is the fall in mortgage rates. Britons are much more likely to have variable-rate mortgages than Americans, so they have benefited more extensively from the sharp fall in short-term interest rates. According to the CML, the proportion of British incomes devoted to mortgage-interest payments fell by four percentage points over the 12 months to November 2009.
But now that rates are about as low as they can get, that boost to affordability cannot be repeated. Another key measure has already moved against borrowers. Lenders now require first-time buyers to put up a bigger deposit than was customary during the boom. In November the average deposit was 25%, compared with just 10% in 2007, according to CML figures. In cash terms this means a first-time buyer needs a deposit averaging around £34,000 ($53,000), up from around £15,000 three years ago. Some can raise this money from relatives, but only 36% of loans are now made to first-time buyers, down from 55% in the early 1990s.
The outlook for both markets is uncertain. American houses may look better value but the impact of continued foreclosures and the end of the tax credit may make a recovery hard to sustain. In Britain it is hard to see what can keep house prices above historical valuation levels. It surely cannot be expectations of rapid income growth. Taxes for high earners are going up in April and the new government (an election is expected in May) will have to focus on deficit reduction. Whether this is achieved by raising taxes or cutting spending (by laying off public-sector workers) may not matter much for disposable incomes. And if the deficit is not tackled, interest rates will rise as markets take fright.
The relative lack of housing supply in Britain may explain some valuation premium relative to America?around 7% on a price-to-GDP-per-head basis, calculates Mr Joshi. But the actual gap at the moment is more like 45%. In short, British house prices are still far too high.