As most of you will have no doubt read in the media over the last few weeks,  there are various reports of ‘green shoots’ appearing in the economy. Certainly talking to friends and colleagues in and around the property market, there are increasing anecdotal stores of properties now starting to sell, particularly in the more desirable parts of London, backed up by statistics from the major estate agents of increased registrations and viewings. Whilst transactions remain low for the time being, the increased activity is being driven by potential buyers coming to the view that now is a good time to get into the property market.

 

There are a number of differing views about the extent and timing of the current property decline, with our view remaining that property prices will begin to stabilise in Q3 this year. Even if you do not share this view, one thing is very clear and that is that property is now the most affordable it has been for an entire generation.     

 

 

Property prices in a historical context

 

As we have covered in a previous blog, the house price decline of the early 1990s was more severe that most commentators generally now report. The reason for this was inflation. In 1990 inflation was running at close to and at certain points over 10% (with interest rates over 15% for a period). When you include inflation, prices in the South East actually fell, in real terms, around 45%.    

 

Whilst inflation is important, what ultimately underlies long term house prices is affordability. A key component of this is wage inflation which historically exceeds inflation by 1 – 2% per annum .  If we look at wage inflation (Office of National Statistics) and house prices (HBOS Seasonally Adjusted quarterly index)- both from the same starting point (the 1990 downturn)- and adjust both for inflation, we get the following picture:-  

 

 

 

Why most commentators get it wrong….

 

The temptation and error many people make is to draw the conclusion that that house prices are still overvalued relative to the peak of 1990 as house prices are still now above the 1990 correction point. But average earnings are just one (and arguably the more minor) of the two main components of affordability, the other being actual Interest rates. The high inflation of the early 1990s was (unsurprisingly) coupled with high interest rates. In 1990 interest rates peaked at over 15% and whilst they have fallen since this point, until the last few years, rates have generally remained significantly higher. To simply therefore look at house prices outside of their historical context is to miss the point altogether. This explains why many commentators failed to call the top and also for the same reasons why they will fail to call the bottom

House price affordability since the 1990 downturn

 

Taking inflation into consideration, houses were at their most affordable at least in the last 25 years, at the beginning of 1997. Significant prices falls in the early 1990s , followed by a period of low/stagnant house price growth against a backdrop of high inflation (by recent standards) marked the low point of prices. If we are therefore looking at the point of greatest (relative) affordability in the last 25 years, in an attempt to determine the point where the house prices could currently settle, 1997 is the logical reference point.

 

If we start both house prices (consisting of the HBOS Seasonally Adjusted quarterly Index) and affordability, (consisting of wage rises coupled with changes in interest rates), at the same point at the start of 1997 and then run them through time, the following picture emerges:-

 

 

What the graph tells us is that until mid 2003, rising wages and falling interest rates corresponded almost perfectly with rising house prices.  In short affordability in real terms through this period effectively remained unchanged. After this time house prices accelerate BUT although housing became relatively less affordable, it would be wrong to conclude that housing starts to become generally unaffordable. With 1997 representing the nadir, it could only be expected that prices moved away from this point as the market recovered.   

 

As prices have dropped over the last 18 months, so have interest rates (please note that we are using the interest rates customers typically pay NOT Bank Base Rates). With low/no inflation to speak of wages inflation will remain suppressed, but even with this it is clear that in Q3 this year we are likely to reach the last point, over 12 years ago, when housing was this affordable in real terms.  

 

 

Other factors to consider    

 

Whilst a three factor model can never hope to capture the plethora of factors that could influence house prices, the remaining factors in our view largely counteract each other. On the one hand we have rising unemployment that may deter some people from buying combined with a shortage of funding for ‘more risky’ mortgages. These are  juxtaposed against a continually (especially now new house building has largely ceased) increasing property shortage driven by an increasing population and more single occupants. Additionally and importantly, the above graph assumes that people are prepared to commit the same level of income to property purchase through the period in question. Evidence (particularly from Savills research) suggests that the level of income people are prepare to spend on getting onto the property ladder has risen significantly over the last 10 years. In short whilst the above graph may not be spot on, we feel if anything it may well underestimate affordability.

 

 

Does this mean that prices are close to stabilising?

 

Q3 2009 has and continues to be our view as to the bottom of the market and evidence we are now seeing supports this. With prices now the lowest for a generation, it is should hardly be surprising that  buyers are now coming back to the market.