In 2008 Britain's housing market crashed as the global financial crisis locked credit markets and the average home lost around 20% of its value. In 2009, against most analysts' predictions, we have seen a modest recovery with the average value of a British home rising by around 5%. Nobody knows for sure what the next few years hold for the UK's housing market, but I'm predicting that prices will fall in the next few years, with the fall in UK house prices probably starting around mid 2010. Whilst I'm far from certain that my prediction is correct, I am basing it on the state of the market as I currently see it. However, if new evidence becomes available, I am of course willing to review my prediction and, if necessary, change it.
The state of the affairs as I see it as of the 10th of January 2010,
The latest housing bubble started in the mid to late 1990's and continued until the crash of 2007-2008. I believe the recovery we have seen since then has been caused, not by improving market conditions, but by heavy-handed and unsustainable government intervention as the Labour government desperately tried to improve its electoral chances by papering over the cracks in the economy and re-inflating the housing and credit bubbles. The steps the Labour Party took to re-inflate the housing bubble were; near zero interest rates, quantitative easing, and a holiday on stamp duty (essentially the tax one pays when they buy a home). In addition to this, the recovery seems to be based on a low volume of sales which suggests to me that a relatively small number of cash rich buyers are taking advantage of a weak market with a low supply as homeowners hold on to avoid crystallising their loses. I feel this is the true situation rather than a buoyant market with plenty of first time buyers who are the bedrock of the housing market. I'd point to the fact that in 2009 lending was around £140bn, less than half of the £360bn lent in 2007, and that there are no lenders (that I know of) offering 100% mortgages anymore as evidence of this. I'll now go into each of these five points in more details –
Near zero interest rates: Interest rates are still at an all time record low of 0.5% and have been held there for quite sometime now. They might remain this low for quite sometime to come too; but they can't remain there forever, and when interest rates change, there is no where else for them to go other than up. There is a strong correlation between interest rates and house prices as the rates that people are able to borrow money at determines how much they can afford to pay. When interest rates start to rise (as they inevitably will) it will put pressure on borrowers and therefore help to drive down house prices. The Bank of England uses interest rates as a way of controlling inflation. When there is to much inflation, interest rates are put up to reduce the money supply and drive down cost rises (inflation). They might have to do this sooner than people think as VAT (sales tax) has returned to 17.5% from 15% and rising oil prices are also rising – inflation could very well get out of control quicker than most people think.
The increase in stamp duty: The British government announced a stamp duty holiday from September 2008 to December 2009 on properties costing between £125,000 and £175,000 in order to prop-up the property market during the housing crash. But the tax, levied at 1% of the purchase price, has been reinstated and will further drive up the cost of purchasing a new home and therefore drive down the amount of money people have to spend.
Quantitative easing: When reducing interest rates to 0.5% failed to stimulate the economy to the extent that the government and the Bank of England hoped it would, the only option left for increasing the money supply was quantitative easing. The Bank of England effectively 'created' £200bn out of 'nothing' and put this newly 'printed money' into circulation by investing it in banks in the hope that the banks would lend it out. This program is now coming to an end and probably couldn't continue for much longer anyway as the increase in the money supply is only a temporary measure. The Bank of England invested cash in the banks by buying bonds from the banks. When the economy recovers the Bank of England plans to buy the bonds back from the banks and destroy the cash it receives, so that no extra cash is 'created out of nothing' in the long-term. Since all the money spent on quantitative easing will effectively have to be paid back there is a limit on how long this can go on for. The end of quantitative easing will put pressure on lenders which will cause them to tighten their lending criteria; a relaxation of the lending criteria combined with low interest rates was one of the things that lead to the housing bubble in the first place.
The 2009 recovery based on low volume: Believe it or not, for most first time buyers, it was actually a lot easier to buy a house in 2007 at the peak of the asset bubble than it was in 2009 after the housing crash. This is because prior to the financial crisis, borrowers could easily borrow 100% of the property's value and in some cases, Loan to Value Ratios of up to 125% were allowed. This enabled buyers with almost no cash to enter the market. Nowadays, it's pretty much impossible to borrow anymore than 90% of any property's value meaning that first time buyers will typically need to have at least 10% of the property's value in cash to put down as an up front deposit - very few first time buyers actually have this amount of money. As I said previously, a relatively small number of cash rich investors trying to get some property cheap is not a solid foundation for the housing market. In order for the recovery we have seen to be sustainable, the housing market needs a good supply of first time buyers, the high deposit requirements are likely to lead to a shortage of these.
The Labour government's electoral chances: We can't be sure when Gordon Brown and the Labour Party will call the General Election (election dates aren't fixed in the UK) but they will have to do it by mid 2010. All mainstream political parties have shown that they are willing to do unprincipled things that cause long-term harm to the country for short-term political gain, this is probably more true of Blair and Brown's New Labour than of any other UK government in modern times. The measures the Labour government took are unsustainable, probably bad for Britain in the long term (high housing costs don't create wealth, they merely transfer it from the younger generation to the older generation), and are likely to come to an abrupt end after the General Election regardless of who wins. I therefore expect 'reality to be allowed to bite' after the General Election when a new parliament is given 4 or 5 years to try and sort out this mess.
How much of a fall do I expect to see?
Providing interest rates aren't set to the crazy levels they were in the early 1990's I don't expect to see any big double digit percentage falls as I expect homeowners will probably try and avoid crystallising their loses whenever possible. But I do expect the market to fall between now and 2012, at least in real terms anyway. If I had to put a figure on it I would say that there is at least a 70% chance that (adjusting for inflation) housing will be cheaper by 2012 than it is now.
