Tuesday, May 5, 2009

What Will Happen to House Prices?

"Give me a one armed economists" - Dwight D Eisenhower got so fed up with his economists giving him two sides of the argument he came up with this famous quote - referring to the idea that economists wouldn't be able to say but on the other hand...
With house prices some analysts have rock solid conviction that prices will drop another 30% or so. Yet, the case for a large drop may be less than apparent. This is the case for both sides.

Why House prices have further to Fall

Depth of Recession and rising unemployment. With unemployment rising at a record rate more homeowners are struggling to repay mortgages and face repossession. The unemployment rate is forecast to get worse over the next 12 months.

House price Income Ratio. According to the Nationwide building society the ratio between the house prices paid by first-time buyers and average incomes, peaked at 5.4 in 2007. This has since fallen to 4.1. But rather worryingly in the last property bust, the ratio fell to 2.1 in the mid 90s. For the house price to incomes ratio to fall to that level would either require a doubling of incomes (highly unlikely at moment) or 50% fall in house prices.

Mortgage Market still moribund. Despite minor flickers of hope in the mortgage sector. Mortgage approvals remain at rock bottom. With more bank losses still looming, there is going to be no quick return to easy lending. Banks are likely to remain cautious asking for large deposits which put off potential buyers.

Past Trends. Past trends suggest house prices could fall for 4 years. In the last house price crash house prices fell for nearly 5 years. There were the odd months where house prices rose, but, this did not change the underlying trend downwards. (historical house price trends)

Why House Prices may Rebound Soon

Affordability. When deciding whether to buy a house or not, most people look at monthly payments and effective affordability. This gives a more realistic assessment than house price to earnings. On this grounds, extra low interest rates are making buying a house more attractive than renting. Try using this mortgage calculator at the Times. If you assume 0% house price growth, interest rates of 4.5% and 3% increase in rents - most cases lead to substantial benefit to buying a house, especially in the longer term.

Banks regaining profitability. Despite rise in bad debts, banks such as the Abbey are reporting increased profitability. Abbey reported a 25% profit increase in the first 3 months of this year. António Horta-Osório, Abbey's chief executive, expected the UK's mortgage market to return to net lending.

source: economist

More Buyers returning to market. Reports show more enquiries at estate agents. Though it is worth pointing out making an enquiry and getting a mortgage approved are different things.

Future shortages. The government are trying to build 240,000 houses a year to meet expected future demand. This year, that number could be as low as 110,000. It's a simple supply and demand equation. Lack of housing puts upward pressure on house prices.

Conclusion

House prices are being pulled in two ways. Given state of economy and fact house prices still look relatively expensive it seems likely house prices will continue to fall. But, with interest rates so low, the pervading British desire to own a house is being rekindled. Despite the difficulties of getting a mortgage maybe people will find a way to get back on the property ladder.

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