Looking at the Nationwide Historical House Price dataset in inflation adjusted terms (Chart 1), to account for the devaluation of sterling, it however tells a very different story. This tells us that year on year real prices are down £9,006 or 5.2%. By this measure UK house prices are back to levels last seen in May 2003.
A common metric used to get an indicator of potential stock market value is the Price to Earnings Ratio (P/E). I carry this theme through to housing and also show this in my first chart. This shows that today we are sitting on a P/E of 6.8. While being a long way off the peak value 8.3 we are still also a long way off of the 4.6 seen in January 2000. It is this valuation that keeps me on the sidelines of UK house ownership and instead my family lives well below our means in rented accommodation.
Unfortunately, unlike share markets, I no longer think that valuation is a key driver of UK house prices. This is because I am now leaning towards house prices being driven simply by house affordability. I started down this road in a previous post. This means that the average house purchaser will not think or calculate how much a house is worth, but instead just ascertain how much can be borrowed. To enable us to track affordability over the coming months, as with everything on Retirement Investing Today, I need to develop a dataset to reflect this. This is the focus of today’s post and I am going to define this dataset as the Ratio of Average UK Monthly House Repayments to Average UK Earnings at the point of the mortgage being granted. That’s a mouth full so I’ll call it the UK House Affordability Ratio.
To enable us to calculate this ratio we must therefore bring another variable into play which is UK mortgage interest rates being charged on mortgages. The proxy that I will use for these mortgage rates is the Bank of England statistic IUMTLMV which is the monthly interest rate of UK resident banks and building societies sterling Standard Variable Rate mortgage to households (not seasonally adjusted). A history of this dataset is shown in my second chart. Today it stands at 4.22% which month on month is up 1.7% and year on year up 4.7%.
Armed with the Nationwide dataset, average mortgage rates along with assuming a 20 year mortgage and a 90% repayment mortgage (the actual value isn’t overly important as it is held as a constant through the dataset for comparison purposes) we arrive at my third chart which shows the starting monthly repayment amount.
We can then ratio this with Average UK Earnings to arrive at the UK House Affordability Ratio. Even at this early stage this data looks interesting. Remove the credit boom and affordability seems almost like a straight line (the orange lines). This implies that house price falls will only continue if interest rates continue to rise.
As always I would welcome reader’s views particularly as this is such a new dataset for Retirement Investing Today.
As always DYOR.
Note: Readers interested in UK House Prices may also be interested in the Greater Fool UK House Price Index which has also been developed quite recently.
- The proxy used for Average UK Earnings is the ONS KAB9 dataset.
- The Inflation corrector is the Retail Prices Index (RPI) with July 2012 being extrapolated.