House Price Earnings Ratio

This shows the ratio of house price to average earnings for first time buyers. Although first time buyers is only a segment of the market, the trends are indicative of wider trends in the ratio of house prices to earnings.

As expected, the ratio of London house price to earnings is higher than the UK average. This is despite London having higher wages than the UK average. The relative shortage of space for new houses, means house prices in London have been pushed up to over 7 times average earnings at the peak in 2007.

The long term average for house price to earnings ratio is 3.5.

In the last boom of the late 80s, the ratio got close to 5.0. This meant that 2007 set a new record for house price to earnings ratio.

Despite fall in the house price to earnings ratio it still remains above the long term average.

Is it possible for House Price to Earnings Ratios to Increase in the Long Term?

Long Term House Price to Earnings Ratio (FTB)

House price to earnings ratios could increase in the long term if:

• There was a period of stable and low interest rates, reducing the cost of mortgage interest payments.
• If parents increasingly give deposits to children to enable them to buy more expensive houses.
• If there is a continued shortage of housing due to restrictions on building new houses and continued growth in number of households.
• If banks are willing to lend mortgages with bigger income multiples or if banks / government encourage more – part rent / part buy schemes.

The Credit crunch of 2007-09 caused banks to abandon their previous reckless mortgage lending. 100% mortgages and mortgages 5 times incomes were quickly removed as banks ran out of funds to lend. There may seem little prospect of banks returning to this kind of lending, but, that’s probably what people thought in 1995 after last crash.

Problems of House Price to Earnings Ratio.

Just because the long term house price ratio could increase, doesn’t mean it will. If it does increase, it creates various problems:

• More difficult for young people to get on property ladder.
• Higher % of Income going towards cost of mortgages
• Re-distribution of income from young to old.
• Buying a house may depend on having generous parents.
• Increased pressure to take out risky mortgages several times income.

House Price statistics

This difference is of vital importance for people considering putting an offer on a house.

Hometrack found that in March 2009, on average, sellers were receiving 88.8 per cent of their asking price. Slightly higher than the all time low of 88.3% in Jan 2009. This is still a big discount. For a house on sale for £200,000 = £177,600.

The variance between asking and selling price can vary significantly between different regions of the economy.

In a period of rising house prices, this difference invariably narrows as people have to offer more. The difference between asking and selling prices often reflect the time lag between putting the house on the market and selling it.

Currently the average time on the property market is 11 weeks. So in a period of falling house prices, market prices are falling during the long wait. The longer you take to sell, the lower offers you will receive. This is why it is advised to always set a realistic asking price rather than try to remember past values.

For buyers, it is crucial to have an awareness of current selling prices and asking prices to help you make the right offer. It is worth finding out how much house prices actually go for. In the current climate, you could be saving yourself 10-15% on the asking price – a big saving!

Despite a slight improvement in house price statistics in January, the annual rate of house price inflation in the UK slumped to -16% for 2008-09. Source: BBC

The best forecasts for 2009, suggest falls of 5-10%. The worst forecasts suggest falls of 25% or more.

On the Negative side. Many factors are pushing house prices down

1. House prices fell for four years during last slump

2. Economic Recession The recession continues to worsen threatening more unemployment and therefore more home repossessions.

3. Lack of Funds for Mortgages. The Banking Sector is still fragile after more bad debts exposed from credit crunch. Lending conditions likely to remain tight.

4. House prices still expensive. House price to earnings still higher than long term averages

5. Lack of Confidence as falling prices and recession put people off.

• Why House prices are falling

Positive Aspects for House Prices

1. Government encouraging new lending from Northern Rock
2. Nationalised banks may have more stability for lending.
3. Low interest rates make mortgages relatively attractive to renting (if you can get mortgage that is)
4. Long term shortage of housing may come into play at some stage.

• Housing Market Statistics
• Historical house prices

The most important factors for influencing house prices in the UK

Market sentiment. If people see house prices rising and they expect prices to continue rising, more people will buy a house. Also, when confidence in the market is high, lenders are more willing to lend mortgages with small deposits / large income multiples. At the moment(2009) confidence is very low, people see house prices falling so don’t want to buy and banks don’t want to lend mortgages without a big deposit.

Interest Rates. The cost of mortgage interest payments depends on the interest rate set by the Bank of England. If interest rates are increased, the cost of mortgage repayments rises; this discourages people from buying and it may force people to sell. In 1992 interest rates were over 12% and this caused a large fall in demand for housing and house prices fell. However, at the moment (2009) interest rates have been cut very low (1.5%) but demand is still falling. It is cheap to pay a mortgage, but, this is outweighed by the fact mortgage availability is low and confidence is low.

Economic Growth / Unemployment. Strong economic growth and falling unemployment increases disposable income meaning people can spend more on buying a house. It also increases confidence in buying a house. When the economy goes into recession (falling GDP and rising unemployment) many are put off buying a house so house prices are likely to fall.

Mortgage Availability. At the height of the housing boom 2003-2007, banks were liberal in giving mortgages. We saw self-certification mortgages, interest only, 100% mortgages, mortgages 5 times salary. This increased the number of people able to buy. After the credit crunch, the availability of mortgages fell sharply because banks didn’t / couldn’t lend any more. This caused a fall in demand and prices. This factor has shown to be very important.

Supply. A shortage of supply is liable to cause rising house prices, especially in the long term. Due to long term shortages of supply, some predict UK house prices will rise in the long term quite significantly. In the US, they currently have a surplus of housing supply so a rebound in the property market is unlikely. (long term factors affecting price)

Demographic Factors. A rising population will cause rising demand for housing in the long term. As well as population it is important to consider the number of households. e.g. an increase in the number of divorces and single people increases demand for housing more than rise in population

Speculation. When prices are rising, people may buy houses as an investment property. e.g. many foreigners bought houses in the boom years. There was also a rise in buy to let housing.

Ratio of House prices to income. In theory, house prices should reflect a ratio of house prices to income in the long term. However, in the short term house prices can often rise much faster than income because of the factors mentioned above.

Lenders don’t want to lend With falling house prices.

When prices are rising, mortgage loans of 95% value make sense. However, when prices are falling they don’t make any sense. Householders buying on 95% mortgages will soon face negative equity. With home repossessions rising, banks could be left with high debts and losses. Therefore, despite government pleas to offer more mortgages, banks are understandably trying to protect their battered balance sheets and requiring large deposits.

The number of mortgages requiring more than 25% deposit has risen from 54% to 60%. Therefore, although property prices are falling, the deposit required has been rising – hence the improvement in affordability is illusory for a nation that has a very low saving ratio.

People Don’t Want To buy.

When house prices are falling at 15%, and most economists predict further falls of 15-20% where is the incentive to buy? People are choosing the common sense approach to rent rather than buying. This is causing a further fall in demand. When house prices rise, speculative demand increase. When prices fall, demand evaporates. House prices are now in their 3rd year of decline in the US.

House Prices and Economy.

The current recession shows the importance of housing to the wider economy. There are other factors at work, but, falling house prices is definitely having a significant negative effect on consumer wealth and consumer confidence. This is causing the fall in consumer spending which is leading to retail giants going bust and rising unemployment. But, as unemployment rises, repossession rates will rise and people will be nervous to buy. Therefore, the recession causes further declines in house prices.

Bank Balance Sheets

In the credit boom years of 2001-2007, banks were highly leveraged, they lent a high % of their deposits. – especially former building societies like Northern Rock and Bradford & Bingley. This means they are reluctant to lend. But, falling house prices will worsen the financial state of the major banks meaning lending conditions could get worse before they get better.

Falling tax Revenue.

A relatively minor problem, but still a headache for the government. Falling property prices are having a very negative impact on revenue from stamp duty, leading to lower revenues.

Problems for Estate Agents and Construction sector

The recession is affecting all sectors, but estate agents and the constrution sector are particularly affected. It is causing job losses in these sectors. It means that very few houses are being built, exacerbating the long term problem of a housing shortage in the UK.

• Why House prices are falling

• Drop of mortgage lending (there has been 45% fall since this time last year) has caused a big fall in demand for housing. It means that potential homeowners, especially first time buyers are finding it very difficult to get a mortgage. If this freezing of the mortgage market continues, house prices are liable to fall quite significantly.
• A good question is how long will the mortgage crisis last? The Bank of England has attempted to inject liquidity by offering £50bn of government securities; they even promise up to £100bn. However, there are signs that this is not creating extra finance as hoped. Most banks have still not passed on the lower rates. There are also fears that the full extent of the subprime losses have not been accounted for. Therefore, some feel the situation will get worse before it gets better. Nevertheless, over time, lending in the mortgage markets is likely to improve (even if it doesn’t get back to 2006-07 standards). It is in the banks interest to resolve the shortage of mortgage funding. There is demand for mortgages and they should be profitable for banks if they can sort out the issue of raising finance.

Long Term Interest rates.

As house prices slow, the economy will also slow. This should enable cuts in interest rates. This is complicated by a rise in cost push inflation. However, these cost push factors (such as rising oil, food and energy prices) are liable to be short term. It is unlikely that commodities such as food will continue to rise at their present rate. Oil prices may remain high over $100 a barrel, but to maintain the present annual increase in prices, would be very unlikely. In the medium term it is unlikely that we will see a significant rise in interest rates; it is more likely that interest rates will be slightly lower than the current 5% rate. Therefore, borrowing for a mortgage will remain relatively attractive compared to renting. The long term affordability of mortgage payments is below historical peaks in 1991. As a % of disposable income it is not unreasonable to predict that demand for mortgages will remain strong amongst the UK population.

Average House Prices to Incomes Ratios.

Looking at average house prices to income ratios provides the most convincing argument to suggest that house prices are fundamentally overvalued and could fall by upto 45% (as some have been predicting for past 5 years.) House price to income ratios are currently 5.0 as opposed to 2.7 in 1970 (house price income ratios)

There is certainly a decline in affordability, especially for first time buyers. However, there is no obvious necessity for house price to incomes ratios to fall to levels seen in the 1970s. This is because:

• Supply constraints in the UK still exist. America has seen a fall in demand and a corresponding rise in supply of houses. This has left a record number of houses unsold and therefore prices have plummeted. However, at the moment, the UK doesn’t have this situation, the number of new houses coming onto the market is close to a record low. Whilst supply of housing is below the number of households, it puts upward pressure on house prices; it supports an increase in the long term house price / income ratio.
• Medium term interest rates are historically low. The last house price crash came when interest rates were in double figures for several months. This made mortgage prohibitively expensive. But, with rates more than half, paying for a mortgage still remains an attractive option. in Q3 of 2007, mortgage interest payments accounted for 20% of disposable income, as opposed to 27% in 1991. (links)
• Parents Money. To deal with rising house prices, many parents are offering deposits to their children. This is effectively increasing the buying power of first time buyers. It is also creating a situation of inequality, where getting on the housing market is becoming dependent on whether your parents will help you out. This is fair, but, unfortunately leads to a situation where people are willing to pay more for a mortgage.
• Rising Number of Households. The UK has a rising population, boosted by immigration. Social trends are also encouraging smaller household sizes, e.g. rising divorce rates.

The next two years is likely to see falling or stagnating house prices. However, in the long term, I still expect UK house prices to remain high. A long term decline in house prices would only occur if:

• The mortgage crisis became a permanent. i.e. restrictions on lending were maintained for several years.
• Significant increase in supply of housing. In the current climate and with the UK’s tight planning permission, this is unlikely to be resolved in the near future.
• Decline in population. It is said Eastern European immigrants are already fed up with the UK and are starting to return. It is not unfeasible that the UK’s population could start to decline in the medium term; this would definitely undermine house price growth.

Long Run Forecast for UK House Prices.

It is quite feasible that average UK house prices could reach £300,000 in the next 10 years. Such a prediction is bound to inflame those with an emotive attachment to the idea of a massive house price crash. One sometimes feels like a heretic for not agreeing wholeheartedly with the doom mongers. But, in 1992 with house prices having fallen 15% in a year, who would have predicted average house prices would rise to 200% in the next decade?

Long Term Forecast for US House prices.

I can’t see US house prices increasing for much longer

One thing is certain, the UK housing market will continue to provide plenty of room for argument and discussion…

Who Benefits from Falling House prices?

First time buyers. At the moment the ratio of house prices to incomes are very high, close to 5 times salary. Falling house prices will enable increased affordability. Also rising salaries and pricing can mean that real house prices will fall than more than nominal. If you are a first time buyer then waiting for a while can enable prices to become more affordable.

People wanting to buy bigger Houses. If your house price is falling in value, then it will also be cheaper to buy other houses. If you are wanting to trade up to a more expensive house, this will actually make it cheaper.

What Will Happen To Interest Rates?

The good thing about falling house prices is that the cost of mortgages will not increase. If anything falling house prices should encourage the MPC to cut interest rates. This is because lower house prices will contribute to lower growth and lower inflation. However, this is complicated because:

1) Due to credit crisis banks are not passing base rate cuts onto consumers
2) The economy faces cost push inflation, e.g. rising energy prices e.t.c.

Therefore, interest rates may not fall much, but, it won’t become more expensive to pay for a mortgage

The Dangers of Falling House Prices

The main problem of falling house prices is that it will lead to lower consumer spending and could threaten a recession like in 1992. This could lead to lower growth and higher unemployment.

Negative Equity. The other danger of falling house prices is for people who bought recently, especially those on 100% mortgages. With house prices falling, people could be left with a mortgage greater than the value of their house. However, negative equity is not necessarily a disaster. If you are able to keep living in your house and pay off your mortgage payments it will only be a paper loss. In the long term house prices are likely to recover.

If you find yourself in a situation of negative equity the best thing is to try and budget so that you are able to keep up with mortgage payments. Try reducing unnecessary expenditure, and look at ways of raising incomes.

How Much will house prices fall?

The biggest cause of falling house prices at the moment is the difficulty in getting a mortgage. It is the drop in mortgage approvals because of the credit crisis that is squeezing housing demand. The Bank of England have tried to inject money into the money markets. However, if this is overcome, then prices may fall less than some people expect. Interest rates are relatively low, supply is still constrained and there are many people who would like to get a mortgage. If you wait hoping for house prices to fall 30%, you may never get round to buying a house.

Surviving a recession  at Economics Help

In the UK, the supply of housing is fairly inelastic; this means it is unresponsive to changing prices. The number of houses being built is relatively low, therefore, supply increases only slowly. This means that changes in demand for houses will be influential in determining house prices. A small rise in demand will cause a significant rise in price. But, also a small fall in demand will cause a significant fall in prices. (It is a myth that areas with shortage of supply cannot see falls in prices)

What Determines Demand for Housing?

Traditional factors.

1. Incomes. Economic growth and rising incomes means people can afford bigger mortgages so demand for housing rises.
2. Interest Rates.  Higher interest rates increase cost of mortgage repayments, reducing demand for buying.
3. Number of Households. Rising population leads to increased demand. Also, the number of households can increase faster than the population. For example, recent years have seen an increase in the % of single people households. Social factors such as rising divorce rates can influence demand for housing

Less Traditional Factors

1. Speculation. An increase in the number of buy to let investors mean that more homeowners are buying houses for the capital gains. Therefore in a property boom demand from speculators will rise. When prices start to fall, they will be keen to sell.  This makes the housing market more volatile and contributes to a boom and bust nature of the housing market.
2. Availability of Mortgages. If unconventional mortgage are freely available it enables people to take out bigger mortgages. This supports  a rise in the house price to income ratio. However, in a credit crunch there is a squeeze placed on mortgages leading to a sharp fall in the number of first time buyers who are able to get mortgage funding.

See: Why House prices are falling

• Main factors that affect house prices

Of all the reasons mentioned here – House prices set to fall I think the most important reason is the drying up of the mortgage market and the credit crisis. The Bank has promised to inject money into mortgage sector. But, even £50 billion may be insufficient in a mortgage sector worth over £1.19 billion or 85% of total GDP.

The council of mortgage lenders notes that mortgage approvals are down 40% and this is causing a shortgage of first time buyers. In recent years, first time buyers have been able to overcome rising house price to incomes ratios by using mortgage products which enable big mortgage to income ratios. But, these products and mortgages with low deposit ratios have been withdrawn or made more expensive. Therefore there is a significant fall in the number of buyers.

For house prices to fall to their long term average of house price to income ratios, even bigger falls may be expected. However, on the positive side, base rates are set to fall (even if banks don’t pass these on to consumers). Falling house prices are unlikely to increase the cost of homeownership; therefore, for most people who buy a house to live in, there should be no panic to sell.

Furthermore there is still a fundamental shortage of supply in the UK, which may mean that long term house price to incomes ratios continue to be higher than in previous decades.

Alot depends on how deep the credit crisis continues to be for the UK and whether the Bank can do much to unfreeze the credit markets.

Related essays

• Overvalued Housing Markets 
• I wrote an essay on a comparison between the UK and French economy 

Unfortunately, when it comes to measuring house price statistics there are a bewildering array of different statistics and measures. Surprisingly, given the importance of house prices, the government do not have an authoritative overall statistic. To get an overall impression of the housing market, we need to look at a variety of different statistical measures. The variance in house price inflation shows the limitations of house price statistics.

Different House Price Statistics

Asking House Price. The asking house price index measures the average asking price of more than 700,000 homes across the UK. It excludes houses over £2million and houses under £20,000. The benefit of using the asking price or listing price, is that it gives a guide to the future of the housing market. The disadvantage is that selling prices can often differ from the asking price quite significantly. Asking house price index

Nationwide House Price Index. The nationwide Building society has kept data for house prices since 1958. It gives the longest historical set of data. The Nationwide accounts for 12% of the Housing Market. Also has a house price index calculator Nationwide House price index

Halifax House Price Index. The Halifax typically accounts for 22% of the mortgage market. It is one of the biggest mortgage lenders. The Halifax use ‘standardised’ house price data disaggregating seasonal and regional variations to try and give an accurate picture of an average house price . Halifax house price index

Hometrack. Hometrack reports agreed selling prices. Hometrack provide an indepth comprehensive coverage of the UK housing Market producing statistics on not just average house prices, but, also length of completion, viewings per sale and house builds. Hometrack house price statistics

Council of Mortgage Lenders. The CML represent over 80% of UK mortgage lenders. They produce statistics on mortgage lending, average house price to income ratios, arrears on mortgages and house prices. Council of Mortgage Lenders statistics

Rightmove. Based on around 90% of the mortgage market, Rightmove offers statistics on average asking prices across the UK. Rightmove statistics

Royal Institute of Chartered of Surveyors The Royal Institute of Chartered surveyors give a monthly indication of house sales.

Related

• Are House prices falling? – a note on difference between monthly falls and annual house price falls.
• UK Housing Market
• Ratio of House prices to Income

House price Graph at Top powered by - UK house price statistics