No bubble yet in house prices
02-07-2014
We have got used to the housing market glass being half empty over the past five years. As average transaction levels have halved and house prices have dropped about 15 per cent, bumping along the bottom has been the norm.
By Fionnuala Earley
But policies to stimulate the market have done the trick and confidence has gathered momentum in the past nine months. Prices are now growing at an annual rate of about 5 per cent while transaction levels have recovered to 60 per cent of peak levels. The glass is no longer half empty but two-thirds full.
But is it all happening too fast? There are good reasons to be cautious. Spencer Dale, the Bank of England’s chief economist, has said: “The UK housing market has a sort of microwave type quality to it, with a tendency to turn from lukewarm to scalding hot in a matter of a few economic seconds.” The fear that household debt, already much higher than is comfortable, will increase further and leave households – and the wider housing market – even more vulnerable, is valid. Borrowing to buy houses is the reason why household debt grew so quickly in the first place (see chart) and that is dragging on the recovery now.
As prices begin to rise again, the expectation that they will continue to do so acts as a catalyst for demand, encouraging people to buy not just to have a place to live, but for investment too. Low interest rates mean it is cheap to borrow – if you have a big enough deposit – but it is not plain sailing. Low income growth means the debt-servicing burden does not ease as quickly as it did in previous cycles. Back in the 1970s and 1980s, inflation eroded the value of the debt and wages increased quickly, so financial comfort was restored after a short period of pain. The pain lasts much longer now, especially when we are only just coming out of the longest and deepest recession in more than two generations. That means borrowers and the housing market are vulnerable to labour market or interest rate changes for longer too.
So there are risks, but it is too soon to panic or say it is a bubble. There are several reasons why. First, prices are not rising that quickly. After five years in the doldrums, average house prices in England and Wales are still 9 per cent below their 2007 levels and are only rising at an annual rate of about 5 per cent. That should not be alarming, or surprising, given the stimuli from Funding for Lending, Help to Buy and a recovering economy. As BoE governor Mark Carney says, we should expect some catch-up. We should be more concerned if there were none.
We should expect some more too. We expect house price growth in England and Wales to grow by about 6 per cent in 2014 and 5.5 per cent in 2015, as the effect of improved economic conditions, higher expectations of future house price growth and government stimuli feed in. In addition, groups of potential buyers have been waiting for the market trough to make their move. With more finance available, this is possible and renters will also move back into ownership and contribute to demand.
It is true that prices in London and the south are rising much faster and the trend looks to be rippling out to other parts of England and Wales. But this faster rise in prices seems to be driven by a lack of available stock of homes for sale, rather than just higher demand. Data shows the trend of declining stock that started last spring continues. The stock of properties available to buy in December was down 17 per cent compared with a year ago. The trend is most acute in London, where stock levels are 30 per cent down compared with last year, but there are signs that this trend is shifting out.
Inevitably, prices will rise if there is not enough supply. And supply is not just about new building, but about existing owners feeling confident enough – and financially secure enough – to move. But the danger is that as prices rise more rapidly they create unrealistic expectations about how much they can rise in the future. This is what causes bubbles. But a bubble can only inflate if buyers are able to gear up their borrowing in an attempt to beat the market.
At the moment there is no evidence that credit is being made too easily available. Indeed, it was not long ago that we were all blaming a lack of lending for housing market woes. Council of Mortgage Lenders data shows that even among first-time buyers the average loan to value is 80 per cent and mortgage payments (including capital) take up less than a fifth of income. But on top of that the regulator has its eye on the housing market and will step in with measures to cool it if necessary.
The Bank of England’s Credit Conditions Survey signals there may already be some increased caution about future lending. While overall the survey shows that lenders are happier about secured lending – reporting a relaxation in the availability of secured credit both in the last three months and their expectations for the next three – they are much less sanguine about the quality of applications. For the first time since the second quarter of 2012 lenders expect the numbers of applications to be approved to fall, despite their inclination to loosen credit scores. That illustrates that affordability constraints are expected to bite and prevent access to credit where it is not sustainable.
New FCA rules on mortgage lending resulting from the Mortgage Market Review that come into force in April will also strengthen any resolve to remain alert. Households’ spending must be taken into account in the assessment of affordability. Even if this affordability test is passed, the rules require lenders to test future affordability against interest rate rises to make sure the loan is sustainable. That may not be such an easy test to pass as house prices rise.
Using data from the most recent Family Spending Survey, a household in the top 70 per cent bracket of income in the UK earns about £50,000 before tax and spends about two-thirds of its disposable income on things other than housing. Such a household buying a £185,000 home would be able to afford the payments with a 90 per cent loan at an interest rate at 4 per cent without making any economies. But if mortgage rates rose to 8 per cent – not an inconceivable number – that would no longer be the case and the loan may not pass the test.
So will the glass go from two-thirds full to overflowing? Unlikely – prices are rising for good reason. There is an element of catch-up as the credit markets and the economy recover, but also a lack of stock to sell, which pushes prices up. Rising prices alone do not mean there is a bubble to burst – that requires credit markets to be willing. While finance is more available than it was, there are good reasons to believe that affordability tests will keep a lid on things, especially with regulators at all sides ready to empty those overflowing glasses on signs of an overheating market.
Fionnuala Earley is residential research director of Hamptons International
Key points
- Confidence in the housing market has gathered momentum in the last nine months.
- As prices begin to rise again, the expectation that they will continue to do so acts as a catalyst for demand
- At the moment there is no evidence that credit is being made too easily available