House Price Falls Look More Likely Than Not

The more I look at it, the more I am convinced that we might be “at or near the top” for a little while, as regards house prices for London.

House Price Falls Look More Likely Than Not

Why do I say this?

Well, first, and to understand things, you have to go back a while to see what’s been happening over the last 6 years, since the credit crunch.

The credit crunch of 2008-9 was an extreme event, almost unparalleled in the history of banking.

In an attempt to put things right and prevent complete meltdown in the financial system, central bank lending rates had to hit the floor all round the world – dropping to 0.5% in the UK. And, as we are not yet out of the brown stuff, they have had to stay there ever since. Ever since the Bank of England was set up in the 17th Century interest rates have never been so low.

Low interest rates also meant poor returns for savers in the banks and building societies. As a result, in the absence of returns from bonds and stuff in the bank and once it was obvious that financial meltdown had been avoided, the demand (and prices) for other assets, what are often called “real assets” like shares and property shot up like a cork out of a shaken bottle of champagne. (The FTSE 100 went from 3,926 in March 2009 to over 7,000 by early 2015).

This massive drop in borrowing (and savings) rates was a one off event, though the impact on house prices and shares took a few years to trickle through.

But what else has boosted house prices?

Well, obviously confidence that house prices are going to stay up affects house prices – but confidence is always a tenuous thing and it can change fast! Funny foreign money looking for a home in a safe haven far away from grabbing foreign governments is a big factor in London in particular, but this can swoosh in and out very fast in response to relative foreign exchange rates and the relative attractiveness of other safe havens. Without doubt London has “benefitted” a lot in recent years from foreigners buying up our capital, but this could be a one off. (Not sure all the foreign stuff is good for our economy but that’s a different political issue).

Peoples earning power obviously drives house prices too. Simply put, the more you earn, the more you can borrow to buy a house.

Another thing that affects house prices is how willing lenders are to lend money to folk to buy houses. On this matter the picture is a bit mixed. On the one hand we have the “mortgage market review” which has made it very hard for older folks and the self-employed to get residential mortgages, but on the other hand there has also been some loosening of lending criteria for other people. So, I would say the picture on lending is mixed and probably neutral overall.

Housing Demand and Supply Imbalance

The other big thing that affects house prices is how much housing there is compared to the demand for it. And this is the biggie.

The population of the UK has been swelling ever since the 1990s when the UK’s economy started to pull ahead of the rest of Europe. This, combined with a lack of tight, (many would say fair), European-style regulation of labour markets, meant the UK became a magnet for workers from around the world. Unemployed and under-employed people from Europe (and elsewhere – just look at the Med between Libya and Italy!) have been coming in in huge numbers the UK to work and to live.

And they need to live somewhere.

Of course, the UK has failed to build enough houses, (vested interests at play here!). So, unsurprisingly house prices have risen, especially in places like London and parts of the South East and to a lesser extent in the East of England and East Anglia where migrant concentrations (and consequent pressure on housing) are highest.

This much is simple demand and supply.

This migration does not seem likely to stop anytime soon, so house prices could remain under pressure to rise for a long time yet. Or at least, that’s the conclusion of many.

But here is the clincher. As the UK’s population grows ever bigger, the demands on things like roads, railways, healthcare, schools, sewers – and all the other things a state needs to provide also rise too. And so, we continue to see a rise in spending on this stuff. (Just think what Cross Rail has cost. If the population of London had not grown so much, this multi million pound project may never have been needed).

All this means that taxes must rise to pay for this stuff. (That means personal taxes mainly, as multinational corporates with their clever accountants and lawyers will likely remain able to resist paying much at all).

And as personal taxes rise, people get squeezed. With less net earnings in their pockets they cannot afford to pay as much to buy property. And it is this which I think will put a limit on house price rises and may even make them fall in the next few years.

Of course, if you are someone who believes that the impact of migration on the UK economy is massively positive, then you will draw a different conclusion. You will argue that the increases in population will mean there is more than enough money to pay for the infrastructure required. You will also conclude that taxes will not need to rise. Your narrative will also be that there will be more population, but still not enough houses ergo, prices of houses will rise. (But see also footnote 2)

Narratives – But Which One Is Right?

I don’t believe that narrative totally, however, because I think the impact of the UK’s open door EU labour market policy is actually negative for the economy once one accounts for the full costs of what needs to be provided by the state.

But there is more. Another little thing to worry folk is the spectre of deflation. Deflation could become entrenched and if it does so for too long and it starts to hit earnings, this must surely spread to real assets like houses.

Of course, in the long term, interest rates can probably only go one way: up. But that would probably require inflation to set in first. But rising interest rates, coming up from a very low base, would make mortgages harder to pay (so, more defaults and forced sales) and it would make it harder for people to get mortgages too. Both outcomes hit house prices.

What are the counter arguments to this?

Well, one counter argument is that more inter-generation money is being used to help the younger generation get on the ladder. Older folk often think, “Bugger it, I may as well leave money to the kids than leave it to the Chancellor to gobble up in inheritance taxes. After all, property always goes up.” (Ruben – see the comment below – has alluded to the first part of this effect).

If you believe that, then the sky could be the limit as regards house prices.

Another counter argument is that there is a lot of black economy money around. In other words, the true picture for economic activity is rosier than the government’s stats show (see note 1). Add this domestic black money to all the foreign money and that’s a lot of buying power for property.

Food for thought.

The upshot is, if you buy a good property at a knock down price in many locations you will still be OK. And rents could still rise fast, especially if interest rates rise (more folk will have to rent who would otherwise have got mortgages).

Productive Uses for Property

Just don’t be too hopeful about too much capital growth through house price appreciation over the next few years, especially in London, and many parts of the South East. And with rent-yields on lots of up-market London property barely at 2%, we think that any growth in house prices won’t occur in the expensive centre of our capital city. After all, any asset has to have a productive use. And so, you buy shares in BAT to give them cash to flog kids fags, you buy shares in Sainsburys to give them cash to flog people food.

Property is different. It cannot be used to make fags or food or gadgets or anything else. It has just one productive use – to house people, and the measure of this is the rent achieved. Don’t buy property because you think some other sucker will one day pay more, the other sucker may one day vanish. At the end of the day, there must be some link from house prices to the rent that can be achieved on that asset – rent is its only productive use.

That is why I say London looks “toppy” in terms of house prices. Yes, the sky can be the limit, but the sky can also fall in one day too.

Let’s see if I’m right. Also, see the footnotes below.


(1) Every year we holiday in Greece. Away from Athens, all looks rosy as Greeks enjoy lots of food and drink and hang out in the sun. Now there is an economy which must have a massive black economy at its heart! No wonder the rest of Europe is losing patience.

(2) Of course, if aggregate demand falls due to a shrinking / ageing population (less / older people buying less stuff (e.g. Japan, Germany) or simply because new technologies mean we can do what we used to do before much, much faster (basically this affects all the world), then deflation could well set in, in a far greater way than we have ever seen before. 

This is the extreme scenario, in which you will want to manage your assets very carefully and stop looking for capital growth on assets but instead focus more on the real income from those assets. This particular argument (about demography and technology) was very well expounded in a piece in the “Property Investor News” edition of June 2015. Well worth a read.

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  • Hi David,

    I’m no expert in property but perhaps you would be interested to hear my sharing of the experience in Hong Kong and consider whether that may be an alternative outcome?

    1. In Hong Kong because there is also a big supply and demand imbalance.
    2. Due to the drop in interest rate it is cheaper to buy than to rent. This is certainly the case when comparing the cost of interest and the cost of renting. Cashflow wise is a bit more complicated because it depends on the LTV ratio.
    3. There is not so much a increasing taxes factor but disposable income has always been declining when compared to property costs, no matter renting or buying.
    4. Family sizes are getting smaller.

    About 1-2 years ago when people in HK realized that the government will not be able to produce sufficient supply to meet demand for a long time to come, people who don’t want to miss out on the property ladder bought whatever they could afford. As a result small sized units prices shot up. On a psf basis, small sized units are now more expensive than large sized units!

    So I wonder whether the same may happen in London where the population will only continue to increase due to continued urbanization.

    1. Demand supply imbalance – unlikely to change in the short term.

    2. It is cheaper to buy than to rent (assuming that one can afford the down payment which the government is providing help).

    3. Chinese people are very much aware of the effectiveness of property as a wealth building tool. I understand that people in western countries are less aware of that. So will the day come when Londers realized that they need to get on the property ladder also?

    4. Due to cultural difference, more Chinese people finance their first property purchase deposit with the help of their parents. However, will the day come when western parents, many of which are assets rich, finance the deposit for the purchase of properties become a norm?

    In terms of increasing taxes, is it just another factor that reduces the disposable income of most people? Ultimately, it is cheaper to buy than to rent and unless potential buyers see that property prices may go down, people will continue to buy?


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