By Peter Stimson - Commercial Director

I came across an interesting fact the other day. Since 1998 global temperatures haven’t risen. I am not of course suggesting that global warming isn’t a fact or won’t occur, simply that data from the last 10 years does not appear to support the hypothesis. How is this relevant to house prices? Well, despite the fact that house prices are clearly stabilising and in some areas rising, there seems to be a growing body of experts who seem to think that prices in 2010 are set to fall further despite there being little apparent supportive evidence.

Are house prices set to decline further in 2010?

Whilst prices, having falling by circa 23% (peak to trough) now appear to be levelling or increasing, some take the view that the stabilisation is only temporary before another round of price falls occur, in 2010. I was reminded of this last week whilst reading the Fitch view on the housing market. What is particularly frustrating is that the authors of these type of reports rely overtly on pure economics. Housing and house prices, as we have covered in several blogs on our website, isn’t an exact science and treating it as such may not get you to the right answer.

To quote Fitch Ratings. “A 30% fall from the peak of October 2007 would bring this ratio (house price to income) back in line with the long term average. In comparison, the house price declines in the recession of the early 1990s saw the average house price to income ratio fall below the long term trend.” Unfortunately whilst this may be correct in pure economic terms, this theory falls over as soon as you bring interest rates and supply into the equation. As we have also covered in our some of our blogs  the current crisis has seen the breakdown between several factors that may previously have held a relationship.

Our view is that If you want to gain a real understanding of what is going to happen to house prices in the next 12 months or so, the best way to do this is to first understand why prices now appear to have stabilised (or in the south risen) and then look at the outlook for these factors over the next 12/24 months.

So, why have prices recovered?

• Prices fell over 20% peak to trough – By any logic, price falls cannot be indefinite and a point is ultimately arrived at where buyers and sellers reach equilibrium. Our long held view has always been that it was likely to be Q3 2009 given that overall affordability at this time would be at a generational low. As the graph below, which looks at affordability and house prices through time, shows, the historic low point and longer term average between affordability and house prices occurred again in Q3 this year. A co-incidence?

 

• Supply, is constrained This isn’t simply an issue of people holding off buying or choosing to stay put, it is also a long term demand/supply imbalance which has only been exacerbated over the last 18 months as new building has dramatically fallen.

-  Interest rates are low and are likely to remain so.  Whilst the strong relationship between Bank Base Rate (BBR) and actual consumer interest rates (both deposit and lending rates) has broken down, it is easy to forget that new mortgages are still available (albeit to a smaller section of the market) at rates which are amongst the lowest for decades. Additionally, many existing borrowers are finding that the products they took out in the past revert to BBR plus a small margin. In short borrowing is for most people very affordable.

If we accept the above as the primary reasons why house prices have stabilised, for prices to again fall, it is logical that one or more of these factors has to change or another factor has to enter the equation to negatively influence prices. 

The outlook for 2010 and beyond

Of those who believe that house prices are set to fall further again next year, three principal arguments seem to prevail.

• Firstly, as more property comes onto the market the demand/supply imbalance will resolve itself making the property market much ‘softer’ causing prices to fall.o If, as I have seen, the argument is that rising prices will encourage more people to sell/move, I have yet to see any real evidence of this. Additionally the forbearance that lenders are showing to those in arrears means that there is not a ‘wave’ of repossessions or forced sellers hitting the market, more a steady ongoing supply. With interest rates so low, most people can ‘sit it out’. In short we do not see a rapid adjustment to the supply situation occurring at the pace needed to cause prices to decline.

• Secondly, as unemployment rises throughout 2010, peaking in 2011, the argument goes that this will deter many from entering the market and create more forced sellers.
o Unemployment and the general confidence issue it creates in the market, undeniably have an influence on property prices . However I would argue that the fear factor is here already as we are over a year into a major recession. Unemployment numbers may continue to rise for the next two years, impacting individual borrowers, but the forbearance shown by lenders and the relative impact this additional group could have on the market overall is limited.

• Thirdly and most significantly, is the impact on the housing market when interest rates start to rise. With BBR at just 0.50% and unlikely to fall further, the biggest worry is that when rates rise (as they inevitably will do), affordability decreases and prices fall. The important piece here though is around timing.

The future for interest rates

When rates were cut to 0.50% in March this year, there was still a large degree of uncertainty around the length, depth and severity of the recession. More than six months further on, a clearer more generally agreed view is emerging of likely future events. Whilst we now may be at or indeed even past the bottom of the recession, recovery is likely to be long and slow and complicated by the large and growing government deficit. This means that there is little upward pressure on rates in the short to medium term and we believe rates may stay low for several years to come. This is being reflected in swap rates which, from rising in the spring, have been consistently falling over the last few weeks reflecting the general concerns over the recovery timeframe.

 

This doesn’t of course mean that we are entering a Japan style ‘lost decade’ period, simply that with interest rates likely to remain low, the factors that could push house prices lower in 2010 don’t to us appear to be there. Time will of course tell who is right!