House prices to rise!?

I'm still surprised by people's optimism when it comes to house prices. A lot of investors have jumped at the chance to buy property at a 20% reduction from the top thinking that a bottom is in sight. Government figures suggest prices are on the increase and sales are up (which is true of every summer incidentally).

If you look at a chart of house prices, you notice that under normal circumstances, prices rise roughly with inflation, as people maintain the prices and banks lend with a fairly consistent loan to earnings ratio.



The huge spike over the last 5-7 years isn't normal and was caused by the following:

1. Artifically low interest rates for 10 years


2. A complete lack of lending standards and due diligence by banks, including self-certified or so called "Liar Loans".


3. 125% mortgages, no deposits required.


4. Teaser Rates/Option ARM Mortgages.


5. Banks hurt by not jumping on the bandwagon.


6. Huge bank competition.


7. Government guaranteed mortages via GSEs (Northern Rock etc.)


8. Securitised mortages sold to investors so banks aren't taking the risk directly.


9. Vast array of TV programmes telling people 24/7 not to miss out on easy money flipping houses.


10. House prices only go up mantra.


11. British love affair with house ownership.


12. People making a lot of money from property, highly visible.


13. Increasing growth and employment.

The problem for house prices now is the recklessness of those years is completely off the table. Even if the banks were game for it a second time around there is little room for securitisation because investor demand is shot.

Here is a summary of the current and near-term (within 3 years) forces acting on prices as far as I see it. No doubt I have missed some out...

Down Forces

1. New paradigm and mantra of "prices only go up" proven to be false.


2. Tightening lending standards.


3. Lack of Option ARM, Pick-a-pay, CDOs (Collateralised Debt Obligations), ABS (Asset-backed Securities) and other financial engineering.


4. No mortagages above 90%, Deposit Required.


5. No investor demand for securitised mortgages.


6. Rising real interest rates reduces the amount that can be borrowed because of repayments and forces more people underwater.


7. Snowball effect of underwater mortgages defaulting.


8. Banks earning a safe, easy spread between their borrowing at 0-1% and receiving better rates with central banks reduced private lending.


9. Government borrowing crowding out private borrowers.


10. Rising unemployment making default rates rise and the number of new buyers reduce.


11. Rising government debt means a more heavy tax burden to come.


12. Long term Government debt being rolled over into short term debt thereby limiting central bank power of holding down interest rates in the long term without resorting to the virtual printing press.


13. The pound at risk from lack of foreign interest and investment due to worries over unsustainability of British borrowing.


14. Financial sector, engineer of "growth" for 10 years hugely suffering.


15. Britain to lose AAA rating on the cards will mean more inflation because we'll have to quantatively ease and buy our own debt.


16. Rising cost of living from more inflation, reducing disposable income.


17. Savings rate increasing to more respectable figures. Less to spend on housing in the short-term.


18. 1,000,000 empty properties in the UK.


19. Homebuilders desperate to get something for their unsold property.


20. Lack of cheap housing eased slightly by migrant workers returning home as rewards become lower.


21. Lowering prices mean fundamentals must be good to make money in property. No flipping to make easy money curbs demand.


22. Lowering prices mean more equity can be bought by renting and saving and postponing purchase until house values come down to the point where renting is less financially efficient.


23. Complete lack of TV programmes telling people 24/7 not to miss out on easy money flipping houses.

Up forces

1. Government bailout trying to prop up markets, to stop people walking away and defaulting.


2. Government intention of creating a so called "silent decline" where prices stay high, as values drop.


3. Inflated money supply to keep nominal prices high (see above).


4. Central banks attempting to hold down interest rates, at all costs - even the death of the pound.


5. GSEs bailed out and now guaranteeing more and more mortages no private lender would issue.


6. Savings rate increasing to more respectable figures. More to spend on housing, long-term.


7. New-builds practically at a stand-still.


8. British love affair with house ownership still continues.

Now compare the chart above to the one below:

Now tell me again why you think house values will rise?

For more details on this see the moneyweek article the graphs were sourced from.