The recent HBOS index showed that average house prices have fallen by 13.7% over the 12 months to October. On a seasonally adjusted rolling three month basis they are currently dropping at an annualised rate of over 20%. Most commentators believe that there is still a way to go, with a general view that a peak to trough fall of circa 30% is likely before we see some stabilisation.

The current fall in house prices is unusual is in that the catalyst and trigger has been the liquidity crisis and the inability to fund mortgages leaving 2008 gross lending at least 25% down on 2007. Whilst availability of credit is important to the recovery of the market, we are of the view that the current rate of decline will mean that by Q3 next year we will be at or very close to the bottom of the housing market. In other words we believe that we are experiencing a very short, very sharp correction compared to the gradual drift of house prices over some years that we saw in 1991.

A number of analysts have talked about affordability as a key determinant. Our view is that whilst this is undoubtedly a factor, supply issues have changed the long term relationship between how much of their income people are prepared to commit to housing. Simply looking back through time and comparing for example levels of household expenditure on mortgages in the 1970s and those in the 2000s misses the point.

If you subscribe to the affordability argument, a more recent period of analysis makes more sense. Taking 1997 as a start point (this was the point at which house prices started to grow again after the last adjustment), we’ve examined the relationship through time with affordability and house prices both set at ‘zero’. Affordability consists of changes to average earnings and changes to interest rates, house prices is the HBOS seasonally adjusted Quarterly index.

As you will note from the graph there would appear to be a strong correlation between affordability and prices until the beginning of Q1 2004, at which point interest rates rose and house prices further accelerated. Whilst 1997 may not be the point of long term equilibrium in terms of prices and affordability (given that prices had been flat for 5+ years) and hence the point to start the graph, the current rate of decline juxtaposed against falls in interest rates projected forward, has us back and beyond the equilibrium point by Q3 2009.  

Whilst the above is simplistic analysis it does make a valuable point that come the latter half of 2009, prices and affordability will be at very low recent historic levels. We anticipate at this point opportunistic buyers will begin to return. There may be a few months of ‘bumping along the bottom’ but the widespread falls should be over.

Our view on prices is largely supported by a recent article from Savills research published in The Times last week which looks forward and beyond 2010. Definitely worth a read. Click here to view.

Finally in this blog, I have deliberately steered away from the macro factors that obviously influence the debate, the most notable of which is the long term shortage of housing. I will cover this in a later blog.