The house price boom has got to crash
By Chris Gilchrist
It can't go on like this. House prices simply cannot continue to rise faster than
earnings as they did again in 2006. First time buyers can't afford a home in 90%
of Britain's towns.
Halifax reckons the average first time buyer (FTB) paid £151,565 in 2006,
up 11% on the previous year and more than double the £77,814 average for 2001.
Of course there are big regional variations, but in 2006 the average paid by FTBs
in every region of the UK topped £100,000 for the first time.
In London, FTBs paid an average of £251,000 and had the pleasure of paying
3% Stamp Duty (at least £7,500) to the Treasury as part of the price of becoming
homeowners. These rises simply can't go on. Why can I say this with such confidence
after so many experts got wrong-footed by predicting a housing crash last year?
Simple. You cannot have a rising housing market without having entry-level buyers.
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FTBs feel the pressure
In 2006 Halifax reckons there were there were 325,000 FTBs, which is 7%
less than in the previous year. But those FTBs were increasingly strapped for cash.
They paid an average deposit of £28,130, more than twice as much as they needed
back in 2001.
So that's one limit you face as an FTB - how much cash can you raise? Nationwide
reckons parents stumped up more towards FTB deposits in 2006 than ever before, but
thinks they're reaching their own limits in what they can afford to hand over to
their kids.
The second limit is earnings. Back in 1997 first-time buyers' average income was
in line with national average earnings. By 2001, FTBs' income was 20% higher, but
last year the average FTB earned £33,202, which is 35% higher than national
average earnings. Mortgage lenders have increased the multiples of earnings they
will lend, but they too are at the limits, because the first time buyer borrowing
4.5 times their income will use over a quarter of their net income in mortgage repayments.
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BTL numbers are wrong
This means that millions of people with earnings lower than the national average
are priced out of the housing market. So there is an ever smaller number of potential
new owner-occupier entrants to the market.
In 2005 and 2006 this gap was made up by buy to let (BTL) investors. Probably over
half the 150,000-odd new housing units built last year were flats that were bought
as investments. But the rental return on BTLs in the South East is now under 4%,
which is a lousy investment unless you expect capital growth on top.
Effectively, BTL investors in the southern half of Britain are assuming they will
get about 5% a year capital growth as well as rental income. But you have to ask
whether this is possible in the long term, because it assumes that rents will rise
faster than average earnings, causing rents to absorb an ever-rising proportion
of net income.
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Soviet-style rules won't work
So far, the government has relied on a good old soviet-style command method to solve
the problem that not enough new housing is being built to exert downward pressure
on prices. It has instructed regional authorities to permit more houses to be built.
This ignores the reality of the marketplace. Builders could today be building twice
as many houses as they are doing. But they prefer to ration supply, sit on their
land banks and make whacking profits – just as you would if you could get away with
it. The housebuilding companies complain about how slow the planning system is,
but actually the system works well for them and the last thing they want is free-for-all
competition.
Only far more radical treatment is going to sort out the UK's dysfunctional housing
market. It is now fair to call it dysfunctional because it is hampering mobility
and using up resources that would be better spent elsewhere. Think about Germany
and France, where wages are somewhat higher but housing costs (either rent or mortgage
repayments) are about a third less than those in the UK. Who gets the better lifestyle?
High house prices may seem good to people who own houses but they carry a substantial
cost. They transfer wealth from the young to the old and from the poor to the rich.
High house prices create an illusion of wealth, but it only becomes real when you
sell up and go and live somewhere much cheaper (not Wales any more, so maybe Croatia?)
They reduce mobility and are in danger of creating a permanent underclass in the
UK.
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Different rules for Planet London
Now for the joker in the pack that skews everyone's perception of the problem. London
is no longer really part of the UK housing market. A third of the population of
greater London are not ethnically British, and London holds far more than its share
of new immigrants. Of course it does, because London's where the money is.
So you have pressure on housing from below. But you also have it from above. Virtually
every seriously rich person in the entire world wants to own a home in London, because
despite all its problems, London is actually one of the best two or three cities
on the planet. That combined with bumper City bonuses means a steady escalation
in top-end house prices at many times the national average.
How do you sustain free-market principles in the face of these pressures? You can't.
Just think about the buying power there is at the top end of the market, with the
number of Chinese and Indian millionaires soaring as their economies boom.
Bizarre local government system
NIMBYism and our weird system of local government finance, which means
it actually costs local authorities money to allow new housing to be built, are
powerful brakes preventing the large-scale building that would be needed to make
free-market housing affordable.
Because it isn't affordable, the government's Homebuy scheme gives mortgage subsidies
to 'worthy' public sector workers, but it suffers the usual problems of too much
complexity and red tape. I reckon it won't be long before people get the idea that
it might actually be cheaper and more effective for the government to build homes
and rent them to the people we need to make society function.
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Politically incorrect answer
In the short term, there's probably just enough leeway for FTBs for UK house prices
to keep on rising, though at slower rate - maybe 7% or so this year. In the longer
term, there has to be a period in which earnings rise faster than house prices.
I know exactly what's needed to achieve this without a crash in house prices: inflation,
which raises earnings and erodes the value of debts (and in general, transfers wealth
from the rich to the poor). My prediction for 2007: by the end of the year, people
will be saying that a bit more inflation wouldn't be such a bad thing.
