Tuesday, January 31, 2006

Get ready for a flat and boring market

2006 will be a year of consolidation for UK house prices:
Tuesday, 03 Jan 2006

Writing for MyFinances Jonathan Said, economist at the centre for economics and business research, predicts 2006 will be a year of consolidation for UK house prices.

The United Kingdom's housing market is not on a roller coaster ride, although at first glance this may not be easy to see.

When the slowdown in the housing market started in 2004 it was easy to claim that a steep descent was in finally in sight, fifteen years after the last one. Many did and still do.

But whilst some correction must be made for the housing boom, houses are not excessively over-valued. And the correction is likely to take place gradually over the next five years rather than abruptly.

When potential house buyers decide whether or not to enter the housing market they do not compare the price of the house they would like to buy with how much they earn. Rather they compare how much they earn with how much they will have to spend every year in interest payments on their mortgage.

The ratio of house prices to average earnings rose sharply during the recent housing boom to reach 7.5 compared to 6.4 in the 1989 boom. Because of this many have been fooled into thinking that current house prices are not sustainable and that they must collapse.

But interest rates are much lower now than they were in the 1989 house price bubble and as a consequence houses are much more affordable. Average mortgage payments as a percentage of average household incomes reached 45 per cent in 1990 but fell to just thirteen per cent in 2003. This ratio currently stands at around nineteen per cent.

Prices will also be sustained by the limited housing supply. In the short term construction companies may limit new house builds as their profit margins get squeezed. Further ahead, at 160,000 the current number of housing completions is not enough to support the four million population growth forecast in the next fifteen years. This is exacerbated by the UK’s changing demography — the person-to-household ratio is forecast to slip from 2.7 in 1981 to 2.3 in 2020.

Looking at the prospects for 2006, the housing market should remain weak. With government curtailing expenditure growth (this has been propping up households’ incomes), taxes continuing to stream in and oil prices adding to household costs, house price inflation should be subdued through the year.

For an accurate forecast for the year we should look toward interest rate expectations. A weak high street forced a downward change in interest rate expectations in the summer. This prevented a cut in consumer borrowing and as a result house prices have proved more resilient than previously expected.

Currently markets expect interest rates to come down in 2006. If expectations do not change average annual house price inflation for 2006 may slow but remain positive at around two or three per cent. However if inflation worries cause the Bank of England to refrain from lowering the cost of borrowing any further, house price inflation could just about turn negative in 2006.

Although the housing market remains overvalued, the adjustment to the long term trend will be through slower growth and not through freefall. After getting used to news of a ‘house price bubble’, we should now prepare our ears for a ‘sluggish housing market’ as we wait for a return to trend growth toward 2012. '

An excellent analysis that sums up my view of where house prices are heading over the next few years - discounting possible major economic shocks.

Chris Bell

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