Why The UK Housing Market Will Not Crash
1st March 2007
Article from Property Investor News – March 2007
With the average price of a house at £200,000 and residential property making up 53% of household net wealth, whether the UK housing market is going to crash or otherwise makes regular pub conversation.
It is certainly quite easy at one level to worry that the market could crash in the next few years. With house prices rising by 10.2% on average every year since 1996 and average every year since 1996 and average gross earnings rising by 4.2% every year, the ratio of house prices to incomes has increased from 4.4 to 7.9 in the same period.
It is an easy and lazy argument to make that the house price inflation seen in recent years is driven by speculation – and we know that all speculative bubbles must eventually burst.
However, there is one fundamental problem with the housing market in the UK that will prevent a housing market bust: the demand for houses by far exceeds the supply. This fundamental mismatch, which developed after the housing market fully recovered in 1996 from the 1989-1990 crash, is caused by a number of factors – which are likely to persist in the foreseeable future.
First, the UK does not have large enough stock of houses. In 2005, 193,000 new houses were built – the highest in over fifteen years. In her housing review in 2003, Kate Barker said that to bring real house price growth down by a significant amount, the UK needs to build 245,000 houses every year. Government planning restrictions and schemes such as key worker housing , prevent the construction sector from fully responding to the house market’s price signal.
Second, population growth has risen sharply in recent years, boosted because more of the world’s people want to live in the UK. The population of the United Kingdom increased by around 1.7m, according to the government’s official statistics, between 2000 and 2006 (in effect this is likely to an underestimate because of the difficulty in measuring migration flows). This equates to around 800,000 new households. Yet between 2000 and 2006 only 1.1m new houses were built in the UK. This means that 300,000 additional new houses is insufficient to account for the growth rate of churn and second-home ownership, for changing house-type and location demand and for smaller household sizes.
Third, when thinking about buying a house, potential house buyers do not compare their income to the price of a house. Rather, they compare their income to their annual mortgage payments. With interest rates at or below around 5.0% in recent years, mortgages remain affordable when compared with the early 1990s. Although mortgage payments as a share of household income have risen from 15.0% in 2001 to 19.6% in 2005, they remain well below the 34% recorded during the 1989 crash.
Fourth, the new large and rich countries of the world – commodity producing countries and the Asian dragons – remain happy to park their new found wealth in the world’s main financial centres: New York and London. A significant amount of money that flows in to the City of London, by one mode or another – such as £8.8bn worth of City bonuses paid out this year – ends up in the property market.
Fifth, because of the nature of economic growth it is natural that certain areas of the country will see more economic activity as the economy expands. Because of lack of transport infrastructure, these growth areas are unable to geographically increase their labour catchment areas, meaning that more people need to live in certain locations – exacerbating the mismatch of supply and demand.
Looking forward, as long as supply continues to fail to react adequately to the burgeoning demand for housing, it is very unlikely that house prices will crash. However in our latest house price forecast, we do see an upcoming slowdown for UK house price inflation. We forecast that house price growth will slip from an average 8.5% last year to 7.6% this year and 1.5% in 2008, before picking up again. Higher interest rates, tight household bills and an economic slowdown will cut back house price inflation, making talk of a possible crash more of a pub topic. But as long as the fundamentals remain unchanged, in my opinion, a housing bust is very much off the cards.