Wednesday, June 17, 2009

Falling US House Prices

Evidence from the US suggests that the US rice fall have reduced house prices close to or lower than pre-boom levels.

Looking at the ratio of house price to incomes and the ratio of house prices to rent the gains of the boom have been wiped out.
  • Note: These figures are up to the end of 2008, but, house prices are still falling in 2009 and could keep falling into 2010
  • The important thing is that the Housing Market can by its nature be Volatile. In other words, booms in prices are too big; but, house price falls can be overdone too. This is because of the momentum effect in driving house prices higher and then driving house prices lower.

Ratio of House prices to Incomes in US

source of graphs: Calculated Risk

Ratio of House Prices to Rent

This has potentially important consequences for the UK. In recent months, evidence suggests house price falls have begun to stabilise. But, although house prices have fallen significantly from their peak in mid 2007, the ratio of house price to earnings is still relatively high.

The current ratio of house price to incomes is about 4.0. (down from over 5.1) But, less than the lows of 2.5 we saw at the end of the last bust in 1993.

Why Have US House prices Fallen so Much?

1. Extent of the recession. The recession has been much more severe than previous recessions making demand for houses fall

2. Extent of the Banking crisis. This has severely limited bank lending which is essential for feeding the mortgage market.

3. Negative Momentum Effect. When house prices are falling, it creates a negative momentum effect causing prices to keep falling. (it's a very different market to stocks and shares where it's easy to buy when you think there are bargains.

When house prices are falling, sentiment towards buying remains negative giving people incentives to 'wait and see'. T

Differences Between UK and US Housing Markets

In some respects, the UK is different to the US experience. In our house price boom, we didn't have a boom in the building of new houses. In the US, not only are people not buying but there is a large stock of unsold houses putting more downward pressure on prices.

In the UK, people may not be buying but there is not this excess capacity that pushes prices down so much.

Also, whilst the recession has been very deep. Interest rates are also at record lows. For those who can get a variable mortgage, buying a house looks more attractive than renting.

If the house price fall did come to a halt, then house prices would still be relatively expensive and out of the reach of first-time buyers. With this ratio of house prices, it would be hard to see another boom. We could see a few years of stagnant house prices (which in itself would be no bad thing) However, if we were to repeat the experience of the early 1990s when Real house prices (adjusted for inflation) fell much further or if we were to follow US house prices, we could be looking at another 12-18 months of house price falls.

If house prices look cheap now, there may be even better bargains in 2010.

No comments: