Sunday 28 February 2010

UK Property Market – February 2010 Update


I am still yet to buy myself a flat or house even though the ownership of one is important to my retirement investing strategy in the longer term. I have now for the time being even stopped looking on the internet at house prices in the area that I am interested. The reason for this is that in my opinion UK house prices are still overvalued by a huge margin. Last week the Nationwide reported that average house prices had fallen from £163,481 to £161,320, a monthly fall of £2,161 or 1.3%. On an annualised basis house prices in absolute terms are still up annually by 9.2% and if I look at real (after inflation) returns they are still up by 6%.

Even with the fall I am not going to suggest that we have maybe reached the ‘Return to “normal”’ phase as I suggested previously as I don’t want to become the boy who cried wolf . In my opinion this is currently a distorted market and anything can happen. Some quick examples:
- The current government have an election to buy and so could do anything from here.
- The government have already distorted the market through the Special Liquidity Scheme and Credit Guarantee Scheme which is liquidity that shouldn’t normally be there.
- The Bank of England have in my opinion decided to keep the Official Bank Rate at the record low of 0.5% even though inflation is above target and he is now writing letters to the Chancellor.
- The Bank of England has indicated that they are prepared to continue to Quantitative Easing (QE) if they deem it necessary.
- Offers like this being made by banks.

These measures are what I believe have caused the rise since I wrote we had reached the ‘Return to “normal”’ phase meaning that the government and Bank of England can create more (or at least try) house price inflation at the expense of the country in the long term if they want to.

Chart 1 shows the Nationwide Historical House Prices in Real (ie inflation adjusted) terms. The real inflation adjusted fall is very slightly less than that reported by the Nationwide with prices falling from £163,405 to £161,320 (a monthly fall of £2,085 or 1.3%) as the UK Retail Prices Index (RPI) month on month fell by a very small margin.

This chart also demonstrates that compared to average earnings property is still very expensive when a ratio is created of the Nationwide Historical House Prices to the Average Earnings Index (LNMM) and it is for this reason I have yet to buy. In 1996 this ratio was as low as 607 and today the ratio stands at 1,127 compared with last month’s 1,172. If we were to return to that number the average house using the Nationwide Index would be £84,670. Will we ever get that low again?

Chart 3 shows the annual change in Nationwide property prices and compares this with the change in the average earnings index extrapolated a couple of months to match the Nationwide time period as LNMM is still only released to December 2009. It shows that the annual change in earnings is now around 1.2% which is significantly less than the Retail Prices Index (RPI) and the increases being seen in house prices.

So in summary house prices are now decreasing in nominal and real inflation adjusted terms. I still think that longer term real inflation adjusted price declines will have to occur to get affordability back to sensible levels however I don’t know if nominal prices will continue to fall. If the government and Bank of England can engineer some inflation which then feeds into salary increases then we may not see nominal falls as house price to salary ratios can then fall fixing the affordability problem with nominal prices not needing to move. However I just can’t see this today with salaries increasing at a rate which is less than both inflation and house prices. The private sector doesn’t seem in a position to increase salaries however while government borrowing is at record highs the government may listen to the Unions requests for big increases as they have an election win to try and buy. I also don’t know when these falls will occur, we may have started this month for all I know, as the market is currently distorted and may continue to be distorted for some time yet.

For now I’m staying well away from the housing market.

As always DYOR

Assumptions:
LNMM data is extrapolated for January and February ’10.
RPI data is extrapolated for February ’10.

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