Bears against bulls in housing showdown

Who is right about the future for property prices? Teresa Hunter weighs up arguments on both sides

HOUSE price bears were in full dance last week predicting that the UK faced several years of falling property values. Capital Economics, the most famous dancing bear of all, forecast mortgage borrowers faced the loss of a further 10 per cent of the equity in their homes.

To the astonishment of many, English Housing Minister Grant Shapps said he thought a 2 per cent annual real-terms fall in house prices for the next ten or 20 years would be a good thing.

He told the BBC: "Just as your fridge and your car and so many other things have become more affordable, over a period of time, so would homes."

The thoughts of an English housing minister would be largely irrelevant in Scotland, were it not that the two property markets move mainly in tandem, albeit with occasional lags.

Furthermore, other commentators piled in, echoing these doom-laden forecasts, which hit confidence again. So where were the bulls, those indefatigable creatures which usually come out fighting against all odds?

We decided to challenge the property bears and bulls by testing their mettle with a range of data.

Traditionally, house prices moved up in line with average earnings, but this rule of thumb was distorted by the last boom. Over the past 50 years, while house prices rose by nearly 6,400 per cent, wages climbed by only around 4,600 per cent.

Historically, property snakes as well as ladders kept the ratios on an even keel. For example, after the boom of the 1980s, property fell during the first half of the 1990s by 11 per cent, while wages grew by 34 per cent.

However, this pattern was broken from 1998 onwards, when property wealth significantly outgrew wage rises. House prices more than doubled, while earnings increased by only 40 per cent.

Given this overshoot, some further realignment seems inevitable, so it's one point to the bears.

Bears 1 - Bulls 0

The bears must win a further point when we look at transactions. At around the 300,000 mark they are lower than at any time since 1974, before the days of mass homeownership, at a time of oil shock and the secondary banking crisis.

Bears 2 - Bulls 0

We should give the bears further points for both the scarcity of mortgage finance due to the credit crunch as well as the threat of new regulation. The Financial Services Authority wants to restrict lending further. If its planned new rules go ahead, Capital Economics is confident that prices will fall by more than 10 per cent.

Bears 4 - Bulls 0

The bears also deserve a point for the interest rate risk. Mortgage rates are historically and indeed artificially low. House prices will inevitably be threatened when rates rise.

Bears 5 - Bulls 0

Finally, we can give the bears a point for income multiples. Over the past 20 years, the typical new advance represented a multiple of 4.08 times average male earnings. Across the UK that hit 5.7 at the height of the boom. It has now fallen back to 4.64. There are good reasons why it may not return to its long-running average, but it is not irrational to believe this ratio has further to fall.

Bears 6 - Bulls 0

Scratch below the income multiple figures, however, and it becomes clear they are distorted by some very strange regional variations. In Northern Ireland, for example, house prices topped earnings by a multiple of eight at the peak. The South West and South East of England narrowly missed seven while other areas such as the West Midlands topped six.

By contrast, Scotland's peak of 4.7 was decidedly modest, and has anyway already fallen back to below the long-term average at 3.8. This indicates that while some regions may suffer further adjustments, the UK price-earnings ratio can arrive at a more comfortable place without significant price falls in all regions. That has to be worth three-quarters of a point to the bulls.

Bears 6 - Bulls 0.75

Their position improves further when we look at affordability. Whereas pre-credit crunch, across the UK, mortgage repayments swallowed nearly half of post-taxed earnings, this has dropped to around 30 per cent. In Scotland the position is healthier still, with mortgages accounting for just 23 per cent of post-taxed earnings. But this will change when interest rates rise, so we will give the bulls three-quarters of a point.

Bears 6 - Bulls 1.5

On the regulation front, there are signs the FSA may be forced to soften its position. Chief executive Hector Sants has been called into the Westminster government for discussions about its mortgage proposals after concerns were raised, not least by Scottish ministers. That's got to be worth another three-quarter point.

Bears 6 - Bulls 2.25

On the mortgage famine front, Prime Minister David Cameron intervened last week when he criticised lenders for being too cautious and holding back the housing market.

He called on the banks for a return to "respectable" lending and said a vibrant housing market was vital for a healthy recovery. Whether political pressure lives up to the rhetoric remains to be seen, so we have to give the bears some benefit of the doubt. Half a point this time to the bulls.

Bears 6 - Bulls 2.75

Then again, when the banks finally unravel their toxic loans in about two years, mortgage lending will return to normal, a prospect of which we can be reasonably certain, and for which we can award the house price bulls a whole point.

Bears 6 - Bulls 3.75

Transactions are climbing, albeit slowly. Some 285,000 mortgages were granted to home movers for the first ten months of last year, according to the Council of Mortgage Lenders. This compares with 250,000 for the same period in 2009. It could be that the tide has turned, which has to be worth another half a point to the bulls.

Bears 6 - Bulls 4.25

When it comes to interest rates, the weakness of the economy would seem to indicate against any sharp rate rise in the near future. Even when they do come, households should be able to withstand slightly higher bills, provided any change is managed carefully. Another three-quarters of a point to the bulls.

Bears 6 - Bulls 5

But it is when we examine property price moves after inflation that the bears are done for. In fairness to Capital Economics, it says its 10 per cent further fall prediction does not take inflation fully into account.

Inflation-adjusted house prices are considered the most reliable guide to what is happening in the property market. During the recessions of both the 1970s and early 1990s, UK property prices fell by 35 per cent after adjusting for the Retail Prices Index.

The uncomfortable truth is that they have already fallen by around 26 per cent in real terms over the past three years, according to the Halifax house price index.

If RPI stays roughly where it is, at just under 5 per cent, and prices hold, then by the end of this year property will have fallen in real terms by more than 30 per cent. Actual prices will not have fallen and existing homeowners will not have suffered any loss of equity, but technically property will have become more affordable and the end of the downturn must surely be in sight. For this the bulls deserve two points.

Bears 6 - Bulls 7

So will the price of your home be lower at the end of this year than it is today? According to our analysis, the bulls have it, winning by seven points to the bears' six. But there is no denying it is a close call.

As for whether we are in for a prolonged real 20-year house price fall, as advocated by the Grant Shapps? You can do the maths yourself.