Sunday 28 October 2012

UK House Value vs UK House Affordability – October 2012

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. 

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 now we will stay with using the Nationwide Historical House Price dataset for this topic.  September 2012 house prices were reported as £163,964.  Month on month that is a fall of £765 (0.5%).  Year on year sees a decrease of £2,292 (-1.4%).
  • UK Real House Prices.  If we account for the devaluation of the £ through inflation (the Retail Prices Index) we see a very different story.  Month on month that £765 decrease turns into a decrease of £1,761 (-1.1%) and year on year that £2,292 decrease grows to £6,880 (-4.2%).  In real terms prices are now back to those around March 2003. 
  • 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.  August 2012 sees earnings rise to £473.  Month on month that is an increase of £2.  Year on year the increase is £10 (2.2%).  With inflation (the Retail Prices Index) running at 2.9% over the same yearly period 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).  September 2012 sees this reach 4.28% which month on month is a tiny uptick of 0.01% and year on year is an increase of 0.18%.  So while the Bank of England holds the Bank Rate at 0.5% out in the real world we are seeing mortgages creeping up very slowly. 

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 6.7 which is identical to last month.  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. 

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.

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.

Click to enlarge

The small decrease in house prices combined with the tiny increase in the Standard Variable Rate sees the Monthly House Repayment fall slightly over the month to September from £919.63 to £916.15.

We then ratio this with 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).

Click to enlarge

As always DYOR.


  1. Hi RIT

    Good analysis as always, however its important to note that just because prices are higher than the long term average, does not mean they are overpriced, or indeed poor value.

    As I know you have a voracious appetite for knowledge to guide your investing decisions, can I suggest you read the 2012 research paper by Hilber and Vermeulen which notes the supply of housing is now 3 million short of the long term equilibrium position, with house prices being 35% higher as a result.

    Given that the chances of building an extra three million houses, above the one and a half million we'll need for population growth in the next decade alone, seems to be pretty much zero....  I rather suspect that a new definition of "value" in the market will be required if anyone alive today is ever to see such a thing.



    1. Hi A1

      Thanks for the thought provoking comment and the research paper tip. It always seems that you think very differently to me on these issues which I hope is making both of us grow our knowledge and understanding.

      I am always wary of thinking we have reached a new paradigm as time after time in history this has proven itself to not be the case. Your point about us being 3 million houses short is however very valid as that will clearly affect the supply and demand relationship.

      As a contrarian I just can't help but to be careful around such statements though. If we were to see interest rates rise sharply (which can happen anytime the market decides in a global world like we live today) then it won't matter about shortages. People will be forced to share more, sell 2nd homes, move back home to parents and EU citizens will move to more favourable regions which would then affect that supply and demand relationship.


  2. There is no new paradigm

    Alongside the increasing population of the country the UK population is getting is older therefore it has less ability to pay off loans to pay for houses

    That ever rising line of best fit for house price multiple of income is the biggest crock of **** I have ever seen

    Its simply not possible for house prices to increase to an infinitely high multiple of salary

    The one off trick of pulling women into the workforce has been done

    Whats next?