We sit at the top of a long running property boom, which has been exacerbated by a Government which is led by people who believe that they can abolish economic cycles merely by saying the words “no more boom and bust”, while pursuing precisely the policies which have caused and exacerbated the property boom.
The boom has been bloated by cheap and easy consumer credit, massive Government borrowing and the irresponsible behaviour of lenders. For some people the fact that days, even years have gone by and they have seen no crash proves that it will not happen. Rather think more of someone waiting for a train, the non arrival of the train does not mean that it will never come, it just means that each minute that passes the probability of its arrival increases. Every minute that passes makes it more dangerous to step on the track, not less. With a property crash, the longer it is coming the harder, longer and more painful it will be.
However, many commentators continue to look forward to a soft landing for the property market and base their optimism on three things:
- Interest rates remain historically low and unless some other factor in the economy, rising unemployment, or a more general slump occurs, then prices will not be forced down because demand will remain strong.
- There is a shortage of supply and we need millions more new homes to satisfy the demand.
- There has been a fundamental shift in the income multiples that people will have to borrow to buy homes.
Nothing is going to happen to cause a crash
Leaving aside that booms and crashes are driven more by sentiment than anything else, it seems to me that this is fairly easy to debunk. Firstly, the credit crunch is dramatically changing the practices of lenders and the losses sustained by banks will result in an altogether more cautious attitude to mortgage lending. In other words, the easy supply of credit, necessary to sustain a boom, has gone. Secondly, the Brown “economic miracle” is the result of high levels of Government borrowing which will have to come down and are indeed projected to come down. This will impact on public sector funded jobs, both direct and indirect and on Government capital projects and therefore the economy as a whole. Thirdly, the financial markets, already jittery on the back of the credit crunch will, at some point, go through a period of retrenchment. This last may be caused by oil price rises or simply the drying up or increase in the cost of credit as the US starts to raise its interest rates.
The thing is, I am not saying that one of these things needs to happen now, or next year, merely that it will happen at some point before the market has completed the hoped for ’soft landing’.
A soft landing will take more than a decade to be completed!
I really don’t see how anyone would believe that there will be no bad economic news, ever, during that time frame. Can anyone point to any decade of which that has been true? The charts below show this in practice. The first is from the Nationwide Building Society, the second extrapolates forward the long term trend, and, as can be seen, even if house prices don’t rise at all in real terms it will still be 2018 before the soft landing is complete and equilibrium is restored.
Chart 1 Nationwide “Real House Prices” (prices adjusted for inflation)
Property is in short supply and will remain so
The argument runs that there is a long term shortage of supply, because we have an increasing population choosing to live in smaller, more numerous households and it will require millions more units to house it.
Well, the indigenous population is roughly stable.
Immigration is optional.
- We don’t have to accept immigrants from outside the EU. There is an increasingly negative climate about immigration and once people start quoting Enoch Powell, you can expect that Gov will want to be seen to be doing something about it.
- EU migrants have been coming here because of short term economic factors.
- Most of them would much rather be at home and when the debt-driven boom we have been enjoying ends, they will either go home, or move on to the next country, be it Germany, Spain, Denmark or wherever.
So the more people need more houses bit doesn’t quite stack up.
Secondly, the other part of the argument is that the number of households is increasing - i.e. even with the same number of people, our desire to live in smaller households means that the number of housing units will increase. This is true.
But, the large part of the increase in the number of households will be elderly people living on their own. The demand from this group will not be for big houses out on big estates far from where they live now. What they will want are smaller, high quality properties in the places they are familiar with. This demand can best be satisfied by redeveloping existing properties - converting one house into two maisonettes, and by the development of purpose built sheltered homes. These latter are high density and lend themselves well to brownfield sites in the heart of existing communities - if you are old you want to be very near your (remaining) friends and family.
So, given that the extra households should be small, high density and in existing communities, the campaign for more liberal planning in areas which have previously been sacrosanct is exposed. It is simply more profitable for major builders to work on big, greenfield sites than small brownfield ones and it has nothing to do with the real housing needs or wants of the people who will be effectively obliged to buy and live in them.
There is one last area to debunk and that is the relatively minor factor of increased demand for second homes. Well frankly, what do you expect in a housing boom? People with money to spare, who otherwise would invest their money in shares or pensions funds see the speculative gains of the buy to letters and decide that they too “can’t lose on property” and divert their capital. If the speculative gains dwindle so will the demand.
So, given a stable indigenous population and smaller households made out of existing units or redevelopment of existing units, there is no fundamental demand for 3,000,000 new builds. I am not arguing that no more new developments will be needed to achieve a sustainable balance in supply and demand, just that the real requirements have been both misstated in character and overstated by vested interests.
People will have to accept higher income multiples than historically
This is an example of retro-fitting. I can’t recall anyone forecasting that this would be the case back in, say, 2000. But if you are determined that there has been no boom than you must believe that this is the case in order for price growth to continue unabated. It also helps to justify builders’ demands for freeing up of more land. According to Professor Stephen Nickell, of the National Housing and Planning Advice Unit (NHPAU) “Our projections suggest that, if we stick to existing house-building plans, they (house prices) could get up to as much as 11 times incomes.”.
Well let’s take a look at that.
Median earnings of full-time male employees £487 per week for women the median was £387 (in April 2006)
Let’s assume a couple on median earnings want to buy a house. That means they have incomes of £25324 and £20124 per annum making a total of £45448.
Mortgage Advance (11 times income): £499928.
10% Deposit (where this might be from is another matter): £55548
Purchase Price: £555476
Interest only payments at say 6%: £29995.68
Council Tax: £1,302
National insurance and income tax: £11621
So after paying the mortgage and direct taxes they will have £2529.32 remaining to live on.
Even if Professor Nickell was merely being sloppy and was not referring to household incomes and you based the calculation solely on the larger pay packet, which would reduce mortgage interest payments to £16713.84 then the couple would be left with just £15811 for all other living expenses.
One infers that Professor Nickell recognises that he is simultaneously forecasting the collapse of the UK car market as well as the travel and leisure industries? House prices must reflect what buyers are both capable of paying and willing to pay. Neither Professor Nickell nor any other expert predicted a long term shift of this kind before this boom, and there is reason to do so now.
To sum up, we will not have a crash if interest rates remain low and no other adverse factor in the economy arises in the next decade and we need millions more new homes to satisfy existing demand and there has been a fundamental shift in the income multiples that people will have to borrow to buy homes. I don’t believe any of those are good assumptions to make.