Saturday 22 December 2012

UK House Value vs UK House Affordability – December 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 this analysis we will stay with the Nationwide Historical House Price dataset.  November 2012 house prices were reported as £163,853.  Month on month that is a fall of £300 (-0.2%).  Year on year sees a decrease of £1,945 (-1.2%).
  • 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 £300 decrease stays at £300 as we say no inflation in the last month however year on year that £1,945 decrease grows to £6,879 (-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.  October 2012 sees earnings at £471.  Month on month that is an increase of precisely £0.  Year on year the increase is £7 (1.5%).  With inflation (the Retail Prices Index) running at 3.2% 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).  November 2012 sees this reach 4.33% which month on month is a tiny uptick of 0.01% and year on year is an increase of 0.22%.  So while the Bank of England holds the Bank Rate at 0.5% out in the real world we are seeing mortgages creeping up at glacial speeds. 

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 and also identical to January 2012.  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. 

Real Nationwide Historical House Prices and House Price to Earnings 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.

Real Nationwide Historical House Prices and House Price to Earnings 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.

Starting Monthly UK House Repayment
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 November from £920.37 to £919.47.

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). 

UK House Affordability Ratio
Click to enlarge

As always DYOR.


  1. Your third graph makes me feel a bit better about my (terrible) market timing with property -- 2003 was the year I decided it was all getting too expensive, rather just simply stupidly expensive, to buy in London.

    But it could be a long time before I know whether I was right not to buy then though, given I don't see rates going up (and hence affordability coming down) any time soon.

    Currently it feels like I made a very poor decision (and not just a financially poor one...)

    1. Hi TI

      IMHO the only game in town is now mortgage rates and the Government/BofE are doing a great job [sic] of keeping them down and subsequently house prices up. I'm actually quite surprised they've been able to keep it going so long without the market responding.

      By my calculation they've now QE'd 36% of the nation's debt (not deficit) assuming £375B of QE and £1T of debt. We've then had some great manipulation in the form of Funding for Lending. All of that has taken nearly 3 years. What will they come up with next?

      Given the importance of mortgage rates to the value of housing I think I'll set up a regular post on mortgage rates. Just need to dig out some data on SVR (which I have), trackers and fixed rate deals.