Wednesday 23 January 2013

UK House Value vs UK House Affordability – January 2013

This is the monthly UK House Affordability update, which is the metric that I believe is the key driver of UK House Prices.  It is also the update for UK House Value which is the metric I am using to assess when it is time to buy a UK home.  The last update can be found here.

Let’s first update the key data being used to calculate both UK House Value and UK House Affordability:
  • UK Nominal House Prices.  In recent posts we have been comparing the different UK House Price Indices however for this analysis we will stay with the Nationwide Historical House Price dataset.  December 2013 house prices were reported as £162,262.  Month on month that is a fall of £1,591 (-1.0%).  Year on year sees a decrease of £1,560 (-0.9%).
  • UK Real House Prices.  If we account for the devaluation of the £ through inflation (the Retail Prices Index) we see those falls accelerated.  Month on month that decrease of £1,591 changes to a decrease of £2,385 (-1.4%).  Year on year that £1,560 decrease grows to a decrease £6,625 (-3.9%).  In real terms prices are now back to those around December 2002 (from March 2003 last month). 
  • UK Nominal Earnings.  I choose to use the Office for National Statistics (ONS) Average Weekly Earnings KAB9 dataset which is the seasonally adjusted average weekly earnings of both the public and private sector including bonuses.  November 2012 sees earnings at £472.  Month on month that is an increase of £1.  Year on year the increase is £7 (1.5%).  With inflation (the Retail Prices Index) running at 3.0% over the same yearly period the purchasing power of those that work continues to be eroded.
  • UK Mortgage Rates.  The proxy I use to monitor mortgage interest rates is the Bank of England dataset IUMTLMV which is the monthly interest rate of UK resident banks and building societies sterling Standard Variable Rate (SVR) mortgage to households (not seasonally adjusted).  December 2012 sees this reach 4.35% which month on month is a tiny uptick of 0.01% and year on year is an increase of 0.23%.  We now need to be careful with this dataset and keep an eye on other mortgage types because the new Funding for Lending Scheme (FLS) is now starting to distort the UK mortgage market.  I’ll provide full details in a post soon however I will say that 2, 3 and 5 Year Fixed Rate Mortgages are now continuing falling.  

UK House Value

The stock market uses the Price to Earnings Ratio (P/E) as a possible valuation metric.  I choose to use the same metric to assess housing value and show this in my first chart below.  For Price I use Nominal House Prices and for Earnings I use the UK Nominal Earnings multiplied by 52 to convert to Annual Earnings.   This shows that today we are sitting on a P/E of 6.6 which down from 6.7 last month.  This means property is better value this month than last.  While being a long way off the peak value 8.3 we are also still a long way off of the 4.6 seen in January 2000.

Graph of Real Nationwide Historical House Prices and the Housing PE Ratio
Click to enlarge

Unfortunately, the Average Weekly Earnings dataset limits this analysis to January 2000.  I however want to look at longer term trends to try and judge where fair value may be and even what P/E lows we could expect going forward.  To get an indicator of this I use an older similar dataset which was discontinued by the ONS in September 2010.  This was the Seasonally Adjusted Average Earnings Index (AEI) for the Main Industrial Sectors.  This dataset goes back to 1990 which is sufficient to take us back through the last UK property bust.  I then convert the Average Weekly Earnings dataset to an index and overlay both on the chart below.  This shows that today we are still nowhere near fair value.
 Long Run Graph of the Housing PE Ratio
Click to enlarge


UK House Affordability

I believe that the Average Joe out there doesn’t have any concept of house price value and instead is just interested in how much he can borrow from the bank which is effectively Affordability.  I track Affordability using a dataset I have created which I call the UK House Affordability Ratio.  I define this as the Ratio of Average UK Monthly House Repayments to Average UK Earnings at the point of the mortgage being granted. 

Let’s first calculate the Average UK Monthly House Repayment.  This is calculated by taking the Nationwide dataset, the Bank of England’s SVR dataset along with assuming a 20 year, 90% repayment mortgage (the actual value isn’t overly important as it is held as a constant through the dataset for comparison purposes) and is shown in the chart below.

Graph of Starting Monthly UK House Repayment
Click to enlarge

The reasonable monthly decrease in house prices combined with the tiny increase in the Standard Variable Rate sees the Monthly House Repayment fall from £920.26 to £912.11 month on month.

We then ratio this with the Average UK Earnings to arrive at the UK House Affordability Ratio which is shown below.  Remove the credit boom and affordability continues to be range bound between 0.40 and 0.45 (represented by the orange lines).  The combination of lower property prices combined with a small increase in salaries sees housing become slightly more affordable. 

Graph of the UK House Affordability Ratio
Click to enlarge

I remain out of the market and am still satisfied with this decision for a couple of reasons:
  • Housing is currently decreasing in price when measured in both nominal and real terms.  Meanwhile my other assets, some of which will be used to buy a home (note I said home and not house as when I buy I don’t intend it to be an investment but rather somewhere for my family to live) continue to increase at rates well above inflation.
  • There is clearly a lot of pressure on earnings given they continue to rise at levels less than inflation.  This is occurring despite unemployment being reported as falling today.  I believe this earnings pressure is going to continue for as long as the world allows itself to continue to globalise.  This is going to eat into the disposable income that people have available to use for buying housing which will put further pressure on house prices.  That is unless the Bank of England / UK Government can continue to drive down interest rates using the FLS or some other new wheeze, thereby preventing Mr Market from doing what should be happening were we operating in a truly free market.

As always DYOR.

9 comments:

  1. Having recently been to see a mortgage adviser (looking at upsizing), he did tell me that most people just look at the affordability of the loan on a monthly basis

    However, I think your analysis is a bit flawed in that it looks at UK national house prices when in fact there is huge disparity in prices/earnings and recent price trends across the UK

    About 50% (I think) of the UK's housing stock by value is in the SE and here is price/earnings is highest and the values are rising, while in the rest of the country to a greater or lesser extent the prices are falling and the price/earnings ratio is much less

    Looking at the UK as just one market is pretty flawed when most people don't have the choice to live in any part of the UK and still have the same jobs/level of income

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    Replies
    1. Hi Anonymous

      I'd like to be able to run some further more detailed analysis comparing different regions but I'm struggling with the Earnings side of the equation. I can't find a reliable regional earnings dataset. Do you know of one that would enable the analysis you mentioned to be done?

      Cheers
      RIT

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    2. There is the ASHE data by local authority on the ONS website, in the data spreadsheets the the local authorities are grouped and totalled into UK regions already (I think these match the regions used for regional house price stats)

      The website says about ASHE:

      "The Annual Survey of Hours and Earnings (ASHE) provides information about the levels, distribution and make-up of earnings and hours paid for employees within industries, occupations and regions in the UK.

      The ASHE was developed to replace the New Earnings Survey (NES) in 2004."

      So presumably they have 8 years data on the ONS website for ASHE and maybe some the older NES stuff too

      You can maybe tell I'm not so statisctially rigourous

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    3. Hi Anonymous

      Thanks for highlighting the ASHE data. I was aware of this data but hadn't used it in the past because it is only published annually and has only been around a few years. This meant I couldn't produce any sensible charts or analysis from it.

      Thinking about it again though in view of your comments. What I could do is use this post as a general trend and then create a table showing the regional PE differences using Land registry and ASHE.

      Thanks for the suggestion. I'll spend some time on it over the coming weeks and see what I can pull together.

      Cheers
      RIT

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  2. Hi RIT

    Are you sure prices are falling in nominal terms?

    I have year on year as follows:

    Land Registry + 1.4%

    Halifax + 2.4%.

    ONS + 2.1%

    Acadametrics + 3.2%

    Nationwide down 1%

    Rightmove + 2.3%

    Oh, and the RICS report has the price balance at zero for the first time since 2010, so it's not even a case of London skewing the figures.

    Cheers

    A1

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    Replies
    1. Hi A1

      With this regular analysis I've been consistent in using the Nationwide dataset and it says a "Standardised House" has nominally fallen in price year on year. Even though it's bucking the general trend I'm not going to change to ensure I remain unbiased and consistent. Who knows next month it all might reverse.

      I agree with you that the different indices are giving different answers by reasonably wide margins. As we've discussed in the past they all measure different things. I'll try and get an update of the Comparison of House Prices topic posted in the near future. We might be able to hypothesise as to what is really going on in the market with that in front of us.

      Cheers
      RIT

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  3. This is a really interesting analysis and I wish I had read this before buying a home in 2005! I've long thought that the UK public behave in this way, but I didn't know where to find the data to analyse affordability. I'm now living in the USA, do you know of any similar analysis or data sets for the US or New York markets?

    RG

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    Replies
    1. Hi Richard

      I know that Robert Shiller has done a lot of work on US housing. If you type "Rober Shiller" into Google you'll find his homepage at the top of the list. Then click on Online Data and you'll find the housing data (in Excel form) he has used in his book.

      Cheers
      RIT

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  4. Have you done a recent update to this post? It would be interesting to see today's numbers!

    ReplyDelete