Here is our first attempt to comprehensively summarise all the arguments for and against house prices going up in the future.
House prices always go up. Did you know that in 1930 the average house price was £590. See this link
According to a parliamentary report a pound in 1998 would have been worth around 0.03 per cent of a pound in 1930. Given that inflation has been quite low since then, let’s assume a pound today would be worth around 0.25 per cent of a pound in 1930. This means that the average house in 1930 would be worth £23,600 in today’s money. So there’s proof, house prices always go up in the long run.
According to the Halifax, since 1950, house prices have increased by 2.7 per cent a year after inflation, while real wages have increased by 2 per cent a year.
According to Nationwide, the average house price in 1975 was £70,617 in 2007 prices, whereas in 2007 the average price was £184,000.
The question is, can we say this trend will continue?
Here is a summary of the arguments for and against:
The evidence of history
The evidence of history is quite compelling. House prices have gone up in real terms over time. It is worth bearing in mind, however, that the data only goes back to 1930. In the years before 1930 the UK economy suffered a very nasty recession. In fact, 1921 was the last time the economy contracted more than in 2009. You would therefore expect house prices to be cheap in 1930. The availability of mortgage credit will also have had a significant effect on pushing prices up since then too.
Take as an example the rise in home ownership. In 1951 just 29 per cent of all homes in the UK were owned by their occupiers. By 2006 this number had passed 70 per cent and was probably close to the highest level it will ever reach.
So the rise in home ownership, which coincided with increases in mortgage availability, will have helped drive house prices upwards over the last half a century or so.
Argument number one: demographics
Rising divorce rates have meant more people living alone, but if they have kids they still want two or three bedrooms. The rising population and immigration, combined with poor planning regulation meaning the number of new builds is consistently too low, has created massive upward pressure on the housing market.
The argument continues: Britain is an island, land is scarce, house prices will inevitably go up.
Against these arguments:
Firstly, why is it that rental costs have not gone up with house prices. If house prices were being pushed up by demographic factors you would expect rent to go up at the same pace.
Secondly, why is it that the US and Australia, where land is more plentiful, also saw significant rises in house prices during the noughties?
The third argument against is more subtle. It seems that many of us live in homes that are bigger than we need. It has been speculated this is because we see our home as an investment. Therefore, there is actually a lot more space in existing housing stock to meet growing demand than is generally realised. See Housing under-supply myth: house price crash may bring families closer together
Finally, there is the difference between aspirational demand and actual demand. The argument that shortage of supply will drive up house prices ignores the fact that people can’t buy what they can’t afford. In the short run, lack of supply may lead to higher prices. But in the long run people normally find alternatives. It is similar to oil. During the 1970s OPEC controlled the supply of oil and it shot up in price. Then we started driving more fuel efficient cars, the US imposed a 50 miles per hour speed limit, and demand for oil fell, and so did price. In the long run the effect of a shortage of homes may lead to more house sharing, or more people living with parents, until prices fall to the level that makes housing affordable.
Low interest rates
Interest rates are so low today that mortgages are more affordable. Furthermore, house prices are much more affordable today than during the late 1980s.
Firstly in the late 1980s we enjoyed tax relief on our mortgages. It was called MIRAS. No study we are aware of which compares modern day affordability with the late 1980s takes this into account.
Secondly, a mortgage is a 25-year commitment. Over this time interest rates may go up significantly.
Thirdly, the initial sum borrowed has to be repaid. At the height of the boom one report predicted house prices would eventually rise to ten times average salary. But even if interest rates dropped to zero, the cost of repaying the principal would surely have made such prices impossible to sustain.
Fourthly, are interest rates really that low? Back in the 1970s real interest rates, that’s after deducting inflation, were negative. By historical standards, real rates may not be quite as low as we think they are.
Finally, here are three more powerful arguments both for and against rising house prices:
The inevitable consequence of getting richer
As a country gets richer we expect some things to get more expensive. So, for example, if we all earn more money relative to the cost of food, this means hairdressers will earn more too. Inevitably, therefore, the cost of getting our hair cut will rise relative to the cost of, say, food. For similar reasons, the cost of teaching and medicine will rise. A company’s legal bill relative to certain other costs will rise.
Maybe the same argument applies to property.
The illusion of inflation
During the 1970s, inflation made property ownership very lucrative. Here is an extract from Bubbles and Wisdom, co written by Michael Baxter founder and editor of Investment and Business News. See www.bubblesandwisdom.com/
“Imagine you had bought a house in 1968, in the period known as the Summer of Love. Well, it seems that 1968 marked the beginning of another type of love, too. For that year may mark the point when your average Briton’s affair with the housing market began.
“Suppose you had bought a house in that year, and suppose your mortgage payments took up 50 per cent of your net income. Then suppose your net income rose over the next few years in tandem with the rate at which GDP per capita rose. I calculate that within 15 years, your mortgage would have taken up a mere eight per cent of your net income. In short, just by letting the force of inflation erode the true size of your mortgage debt, you were able to let the true cost of paying for your home reduce dramatically.
“Inflation in the 1970s shot up, and stood at around 25 per cent at the mid-point of the decade. It was probably around this time that the belief crept into the British psyche that when you buy a home for the first time, you should buy the most expensive property you can possibly afford. ‘It may be a struggle for two or three years,’ went the argument, ‘but once inflation takes its toll, the mortgage will cease to be a burden.’
“Can it be a surprise that the phrase ‘property ladder’ crept into regular usage? Phrases are important. Language influences the way we think. We all know water falls off a duck’s back; we all know a stitch in time saves nine; and we all know there is this thing called a property ladder.
“But by the end of the twentieth century it seems that our faith in property went even further. We no longer thought of a mere property ladder. Rather, we probably had something along the lines of a Jacob’s property ladder in mind.”
In other words, the effect of inflation may have influenced the British to look more favourably on property as an investment asset. We had developed a behavioural response to the property market that made sense in times of inflation, but may not make sense in times of deflation or low inflation. This could create massive problems for the future.
The psychology of the English
Finally, there is another factor behind the housing market which may be unique to the English. They say an Englishman’s home is his castle.
Here is a poem taken from an article by Aida Edemariam called Bricked in, in the Guardian, 4 May 2007:
The Germans live in Germany,
The Romans live in Rome,
The Turkeys live in Turkey,
But the English live at home.
J H Goring, The Ballad of Lake Laloo and other Rhymes, 1909
Or here is another anecdote that illustrates the argument, this time taken from another Guardian piece, by William Keagan, the Guardian, 30 March 2008, Forget restoring the status quo, it’s time to put the world to rights:
I shall never forget the story told by the late Lord Alexander of Weedon who, as chairman of NatWest, visited the Bundesbank when Karl Otto-Pöhl was its president. Alexander was carrying a copy of an English newspaper that displayed a headline to the effect: ‘Good news – another rise in house prices.’ Herr Pöhl commented: ‘Over here, that would be bad news.’
Does it matter?
Adam Smith said, in his book The Wealth of Nations, published in 1776:
“A dwelling-house, as such, contributes nothing to the revenue of its inhabitant; and though it is, no doubt, extremely useful to him, it is as his clothes and household furniture are useful to him, which, however, makes a part of his expense, and not of his revenue. If it is to be let to a tenant for rent, as the house itself can produce nothing, the tenant must always pay the rent out of some other revenue which he derives either from labour, or stock, or land. Though a house, therefore, may yield a revenue to its proprietor, and thereby serve in the function of a capital to him, it cannot yield any to the public, nor serve in the function of a capital to it, and the revenue of the whole body of the people can never be in the smallest degree increased by it.”
Rising house prices do little for the economy. An economy’s economic success is measured by its ability to produce goods and services. The UK economy may have become reliant on rising house prices to fund consumer spending and thus growth. This was never going to be sustainable. The unwinding of the property bubble could mean the UK will experience a period of economic anaemia comparable to Japan’s lost decade, which by the way has now lasted two decades.
© Investment & Business News 2013