Most people I speak to think that UK house prices are ridiculously high, especially in London.
Admittedly, this is not a novel idea. However, as a very minor student of bubbles, I think it’s worth thinking through the possible implications.
So in the rest of this post, I want to outline a) why I think we’re in a house price bubble and b) what the implications might be for the future of house prices in the UK.
Bubble alert: The UK house price-to-earnings ratio is far above average
According to the Halifax House Price Index, the average seasonally adjusted house price in the UK is £217,400. That’s 5.7-times the average UK homebuyer’s earnings of £38,200.
Since 1983, Halifax’s UK house price to homebuyer earnings ratio has averaged 4.2 and so the current value of 5.7 is some 35% above that historic norm.
More importantly, the only time in that whole 33-year period that the UK house price-to-earnings ratio was higher than it is today was between February and October 2007.
So the only time in the last 33 years that house prices have been more expensive relative to earnings than they are today was during the very peak of the last housing bubble.
To make this picture a bit clearer, the chart below shows how the average UK house price has changed over that period, along with the range of values it might reasonably have taken in any given year:
Here’s a quick description of what that chart shows:
- The black line – The average house price each year
- The red zone – Where the average house price would have been if houses were historically expensive, i.e. if the PE ratio had been between 5.5 and 6
- The yellow zone – Where the average house price would have been if houses were at historically average valuations, i.e. if the PE ratio was between 3.8 and 4.5
- The green zone – Where the average house price would have been if houses were cheap, i.e. if the PE ratio had been between 3 and 3.3
The house price rainbow heads upwards over the years as homeowner earnings increase. As a result, what constitutes an expensive or cheap house price also increases.
As you can see, whenever the house price-to-earnings ratio gets anywhere near the red zone, house prices fall back towards more normal levels.
This is because the factors that drive house prices up to expensive levels (such as low-interest rates, a booming economy, relaxed mortgage lending criteria, lack of supply or irrational exuberance about future house prices) do not last forever.
The economy is cyclical and the forces that push house prices up faster than earnings are ultimately temporary and reversible.
So in the long run the house price-to-earnings ratio tends to revert back to its long-term average, given enough time.
And that insight is the basis of my ten-year house price forecast:
Expected capital gains from UK housing are zero over the next ten years
In the long run, I think the most likely outcome for the house price-to-earnings ratio is that it will revert to its long-term average, which is currently 4.2.
If that were to happen tomorrow then the average house price would immediately fall to around £160,600, a decline of some £56,900 or 26%. This is what I refer to as “fair value”.
Of course that isn’t going to happen tomorrow as the housing market is very illiquid. Illiquidity means that house prices move much more slowly than prices in liquid markets such as the stock market.
On a positive note, slow changes in house prices can actually help reduce downside risk. If it takes a few years for house prices to fall, then during that time earnings will typically increase.
So the reduction in the house price-to-earnings ratio is likely to come from both falling house prices and rising earnings, which means that house prices won’t have to fall so far to reach historically average levels.
Here are a few assumptions for the next ten years:
- Inflation – Runs at 2% a year (the Bank of England‘s target)
- Earnings growth – 1.5% a year above inflation (a historically average figure)
- House price to earnings ratio – Declines, reducing the gap between its current value and its long-term average value by half each year (a historically reasonable rate of mean reversion)
This reasonable set of assumptions leads to the following chart which shows my forecast for the “expected value“ of average UK house prices over the next ten years:
Again, a quick description:
- The black line – The expected future average UK house price
- The red zone – Where the average house price would be if it continued to be at historically expensive levels
- The yellow zone – Where the average house price would be at historically normal levels
- The green zone – Where the average house price would be at historically cheap levels
As before, the house price rainbow goes upwards over time as homeowner earnings increase.
Despite those increasing earnings, the forecast is still for declining house prices over the next few years as the PE ratio reverts back to average levels.
However, the average house price is not forecast to fall all the way to its current fair value of around £160,000 because earnings, and therefore fair value, are forecast to rise each year.
So by 2020, the average house price is forecast to have fallen almost back to fair value, but by that stage fair value is forecast to have risen to almost £185,000 thanks to inflation and real earnings growth.
As a result, the risk of a dramatic house price crash is somewhat reduced, but the outlook is still not good.
As the forecast chart shows, there is a very serious chance that average UK house prices will stay flat for the next decade.
Or perhaps I should say “another” decade, given the lack of overall price increases since 2007 (unless you’re in London, where prices are currently well above the previous highs of 2007).
And of course, flat prices would mean that real (inflation-adjusted) prices would decline over that period.
To put it into numbers, this simple model has:
- Average homebuyer earnings at £54,000 in 2026 (which sounds like a lot but won’t feel like a lot in 2026)
- Average house prices at £228,000, just slightly higher than where they are today
The future is uncertain, but the risks are real
Obviously, I don’t actually know what’s going to happen to house prices over the next ten years, just like I don’t know what’s going to happen if I drive down the motorway at 155mph.
But in both cases, it’s possible to make an informed judgement and forecast of the range of possible outcomes.
Some possible outcomes might be good (house prices could stay high and I might make it to my destination in record time and in one piece) while others might be less good (there could be a massive house price crash and a massive car crash).
My conclusion is that in both cases the expected outcome, i.e. the average of all possible outcomes, does not look particularly good*. As a consequence, I will not be re-entering the housing market or driving down the motorway at 155mph anytime soon.
*When I say “good” I mean from an asset class returns point of view. Personally, I think house price mean reversion would be a positive outcome for the UK as I fail to see how excessively high house prices are good for most people or the economy as a whole.
Hello John,
An interesting and insightful piece, as always.
However, whilst I agree with the theory behind your projected rainbow I would suggest that it will become distorted by some other factors, which you mentioned: ‘This is because the factors that drive house prices up to expensive levels (such as low interest rates, a booming economy, relaxed mortgage lending criteria, lack of supply or irrational exuberance about future house prices) do not last forever.’
The key factors here, I would suggest, are future interest rates (and thus the attractiveness of mortgages) and lack of supply and I would further venture to suggest that these are not likely to revert to historical averages in the next ten years, even if they ‘do not last forever’.
I suspect your 155mph motorway trip may well see you arriving breathless but unscathed after all!
Hi Chris, I think you’re probably right that they’re the key factors. As for their mean reversion, I have no idea as there are so many variables. Interest rates may be least likely to mean revert as they’ve been on a downward trend for a very long time. Perhaps zero rates will become a near-permanent feature? I don’t know, so for now I’m sticking with the plain vanilla version of house price mean reversion.
I think UK house prices have been mentally distorted by the change from repayment mortgages to interest only. First via owner occupiers, and then by B(orrow)-to-Let.
This has massively amplified the boom – and there is data to suggest that the majority of super-LTV IO loans are concentrated on the London “market” – as the huge gains in London have been chased by momentum seeking leverage.
IO is no longer available in any meaningful way to owner occupiers – MMR has killed it stone dead. BTL is getting squeezed by the Treasury (S24, SDLT 3%, etc) and the BoE (LTV and affordability testing) who are keen to get leverage rates down in that sector. Reduction in leverage speaks to me of prices dropping at the margin.
Hi Adam, I’d pretty much agree with all that.
Housing bubble version 2.0 has been led by zero interest rates and Help to Buy, which is a bit like the government giving Madoff some money to stop his Ponzi scheme from imploding. But now there are many headwinds. Having said that, irrational exuberance is a powerful force and it may take quite a kick to change that mindset of “house prices always go up”.
But it can change. When I first bought a house in 1995 in London for £40k most people I knew thought it was better to rent because house prices kept going down. That mindset may reappear if house prices stay flat for many years.
I’d love a bit of ‘mean reversion’ over here in Sydney, Australia. Our median house price (Sydney metropolitan area) is now almost 14 times income! (About A$1.05mn median house price versus A$77,000 pre-tax average income)
An absolute nightmare for those of us who are/were trying to get on the housing ladder, and seemingly a source of endless smugness for older people who were lucky enough to buy in the years before the boom and now consider themselves property moguls!
It seems that the issue with mean reversion is that it can take a very, very long time to actually happen.
Hi Tim, that sounds very much like the UK. And you’re right, house price mean reversion is much more gradual than stock market mean reversion, although to a large extent that does depend on supply.
In the US and Spain, for example, they had much larger house price falls post-crisis because they increased the supply of housing much more pre-crisis.
In the UK it’s much harder to get anything of scale built. Not sure about Australia but perhaps it’s the same.
Having said all that there are a lot of caveats. There are big differences between urban, suburban and rural. And in London now there are a lot of residential towers going up, although how much difference that drop in the ocean will make I’m not sure.
Hi Tim and John,
The large house price falls in the US were also at least partly due to a significant number of people coming to the end of introductory mortgage rate periods and realising that they couldn’t afford the repayments at the (very much higher!) ongoing rate. This turned many of them (or their banks) into forced sellers, and prices tend to drop further and faster in a market with forced sellers.
Hi Dave, that’s an excellent point. I don’t think “teaser” rates and “liar loans” were such a big problem in the UK. Also the Bank of England cutting interest rates to virtually zero helped people refinance at more affordable rates, so a US-style crash was averted, or dragged out, depending on your point of view.
In Australia, and especially Sydney, it’s not really lack of new construction that’s the problem:
“forecasts predict almost 185,000 new houses and apartments will be added to the city by 2021 – about 85 per cent more properties than were built in the previous five years”
http://www.smh.com.au/nsw/biggest-housing-construction-boom-in-sydneys-history-on-the-way-20161118-gsspwo.html
Our problem is mainly the combined effects of special tax concessions which subsidise property speculation and investing (negative gearing and capital gains concessions) and the lowest interest rates in history – 1.5% at the moment, which is the lowest it’s ever been in Australia.
Neither the tax concessions (which are highly politically controversial) or the low interest rates seem like they’ll go away soon unfortunately. But you never know, mean reversion can occur suddenly as Ireland, Spain and the US discovered in 2009!
Warning: Sarcasm Alert…
“special tax concessions which subsidise property speculation” – Wow. It’s a good job we don’t have those in the UK.
House price analysis really needs to be broken in two parts, London and everywhere else. London prices move differently as global investors buy property there eg Chinese investors don’t really care about the price they pay they consider London property like gold, a safe haven, and safe from the hands of the Chinese government. Also why they don’t bother renting the property out, if you can afford not to rent the property out then you can afford to throw another few 100k into it without worrying about valuation. Economist Mark Blyth covers this pretty well see YouTube.
If this analysis is done again looking at The uk excluding London it will look different, most places in the uk are not above the previous peak in 2007 in terms of prices.
Hi Raj, that’s a good point. I don’t like to get into regional details too much, but perhaps a London and ex-London breakdown is enough.
As for the London billionaire affect, I don’t think it’s very significant.
The total UK housing stock is valued at around £6 trillion, with London’s housing coming in at around £1.5 trillion (via Savills). So London is about 25% of UK housing value and I doubt that Non-Dom types make up a significant slice of that.
Also, non-resident foreign capital is probably flighty, so it could up and leave at the first sign of serious house price declines. So I think the billionaire-effect, if there is one, is more likely to increase volatility rather than long-term gains.
Non-res capital is here partly (perhaps mainly) for some other reasons:
– a bolt-hole in case the regime in your home country takes exception to you (or there is a violent regime change and your personal network evaporates)
– a prestigious international location
The first of these is more dependent on the amount of bad/risky/mercurial govt in large but unequal (and perhaps corrupt) developing economies. I think this demand will continue to generate an inflow to London.
The second point is more tricky – Brexit and its ramifications might reduce the inflow.
There is also an effect from supply and demand for housing – more so than for equities.
Demand side:
UK population has averaged 0.5% pa from net migration plus about 0.2% from increasing life expectancies.
Demand for homes has been driven by this plus also by decreasing household size and from increases in second home ownership. BTL might be a factor too, as might low interest rates.
I can see the net migration levelling off, Increases in lifespan, decreases in household size, and increases in second homes are likely to continue.
Supply:
Not a lot of evidence of the lid coming off any time soon.
Overally I’d wager on a slower reversion to the mean for property than for equities. half in 3 years rather than half in a year. But the policy and demographic levers could have a big impact!
Hi David, excellent summary of the main points. As for housing, my bet is on a very slow reversion to mean, perhaps much more than a decade. And realistically I think we’re only going to get to average valuations once the mainstream view is that buying a house is not necessarily a good idea. That was the prevailing view in the early 90’s following double digit mortgage interest rates (which we may yet see again!)
Very interesting piece John, thanks. And in line with my own thinking here https://paulclaireaux.com/house-prices-now/
Hi Paul, looks like we’re pretty much on the same page. Your two house price to earnings charts sum the whole thing up nicely.
Bad for some but good for others. As a parent of kids struggling to buy without my help and an awareness that the country is living on debt, there must be an argument in favour of a correction.
Hi Martin, I think there’s a very strong argument in favour of a correction. I think a reasonably slow correction might share the pain and benefits between winners and lowers more equitably, but whether that’s the sort of correction we’ll get is another thing altogether.
John I suppose at some point UK house prices will be good value, as happened in the US where declines of up to 50% happened during the financial crisis. Do you know of a REIT which tracks house prices with leverage to simulate a mortgage? In North America these products are common but in the UK REITs seem to be limited to land and commercial real estate.
Hi Andrew, no sorry I don’t know of any leveraged UK REITS. I think it’s possible to do house price spread betting, which is a leveraged way to bet on a house price index, but I don’t know anything about it, other than that I wouldn’t touch it with a bargepole.
I’m not sure that house prices will fall. Let me explain my thinking.
We always try to link house prices with average earnings and by that measure yes, house prices should fall. However I have a feeling that houses are becoming decoupled from earnings. Houses are being seen more and more as an asset as opposed to somewhere to live, and if the rent you can achieve from a house continues to go up then people will continue to invest in houses as assets, increasing demand and so increasing house values. We have already seen the growth of property funds and buy-to-let.
Also as long as inflation stays low and therefore interest rates stay low then people will look for other ways to invest their savings, one way being property, further increasing the rental market. Of course the Bank of England doesn’t look at house price inflation when considering their interest rates so even though house prices have continued to rise the BofE will keep their interest rates low. And when the BofE pursues quantitative easing all that means is the banks have more money to lend to people which leads to even greater asset-price inflation.
But more worrying I think is the overall trend, historically speaking, of wealth redistribution. I read Thomas Piketty’s ‘Capital in the 21st Century’ a couple of years back and what he notes is interesting is that inflation historically (ie in the centuries prior to WWI) has always been near zero – only major shocks (such as the World Wars) and their aftermaths really cause inflation. I think therefore that, unless we have another major war or revolutions across the western world then inflation will stay very low, near zero probably. Piketty also observes that the value of assets – land, houses, shares in businesses, etc – historically run at a 4-5% increase per year and this imbalance causes inequality to gradually increase as the wealthier are able to buy up the assets, which in turn makes them wealthier and so on. At the end of the 19th century, before WWI this trend had continued to the point where 10% of the population – the land-owning elites – owned 90% of the wealth, the rest of the population had to scrap out for the rest. The two world wars and subsequent rebuilding efforts actually created a lot of wealth redistribution resulting in the birth of the middle class and mass home ownership. However all that redistribution is being reversed, slowly but surely, and the western economies are becoming more and more unequal. The middle class is dying, I’m afraid, and with it the dream of home ownership for the vast majority of the population.
Which is all to lend further weight to the idea that house prices and average wages are not linked, at least not as closely as we might like to believe, and I wouldn’t be at all surprised if house prices continue on their upwards trajectory.
Hi Wephway, some excellent points there.
On your first point that “houses are becoming decoupled from earnings”, I’m afraid I have to disagree. It is impossible for house prices to become decoupled from earnings because ultimately the debt used to buy them is paid from earnings (either directly by a homeowner or indirectly through a landlord). Also, “decoupled from earnings” is exactly the phrase that was used in the dot-com boom to justify ridiculous valuations of internet companies that had no earnings and sometimes no revenues!
On your second point about inequality, I agree. Money comes to money and so there is a natural winner-takes-all dynamic in economics and politics. However, the “peasants” have a tendency to revolt if a) their existence is sufficiently unpleasant or b) a non-ruling group want to become the elite and mobilise the peasants in order to overthrow the existing elite. Both of those factors were clearly visible in the recent referendum.
That might also apply to the housing market. If house prices keep going up then it’s possible that at some point those the number of voters who can’t afford to buy will massively outnumber those who benefit from house price inflation. If those who are losing out get sufficiently miffed, then they could well vote in a party whose primary aim is to build millions of houses. If people under 40 start voting on this in any meaningful way then it could happen very quickly.
I’m not saying it will, but it’s certainly a possibility (as are 10% interest rates, another banking crisis, and who knows what else that could burst this housing bubble).
Prices may not decouple from earnings, but given that we have a situations in which it is generally accepted that “average people” on average earnings cannot buy, why would we expect a connection between average earnings and prices.
Even on the reversion to mean theory, there’s no way to know how long this might take – 5 years, 10 years, 25 years (by which time the mean to which we are reverting may of course be higher). I used to think that average wages not increasing would limit prices (and at some point I guess they must), but one need only look at Sydney as mentioned above, or Hong Kong, to see that it’s perfectly possible for prices to average wage multiples to go far higher than they are in the UK (or even London) now.
Hi arty,
The house price PE in the article uses homebuyer earnings, so prices are extremely high relative to the earnings of those who can afford to buy. The multiple is much higher relative to average earnings of the whole UK population, so by either measure houses are almost unprecedentedly expensive in the UK.
As for mean reversion, you’re right; prices could go much higher than they are today and it could take 25 years before we see reversion to the mean, but I think it’s hard to argue that those are the central or most likely outcomes. There are of course a range of possible outcomes, but on balance I think weak or negative house price growth is much more likely than anything else over the next decade or so.
Hi,
From the perspective of property cycle (which is around 16-20 years), seems home price has bottomed on 1994-1995 (the year you bought), before rising rapidly pre-GFC.
Then home price has taken a major correction right after GFC.
If this is the case, 1994-2010 (bottom to bottom) may already be a full cycle in effect.
I fully understand your argument from a worker earning’s standpoint. But from a cycle point of view, the new cycle has just started for a few years which means a major correction (ie more than 20%) will not happen.
Hi Johnny, thanks for the cycle-base viewpoint. It’s an interesting angle and I do believe that these cycles have a typical pattern and lifespan, but I’m less confident than you in using them to predict future cycles.
Personally I think we’re still at the top of the 1995-20?? cycle. It’s a long top, but that’s because of extraordinary actions from the government that have kept the market at bubble valuations (both deliberately and as a side effect of actions taken for other economic and social purposes).
I guess we’ll just have to wait another five or ten years to see who was right!
There is a spending multiplier to the value of housing (wealth effect) and also home formation.
House values fall, owners become more cautious on spending generally.
Fewer homes formed, less spending.
It will be interesting to see if value falls leading to reduced spending is compensated for by new home formation spending as houses become more affordable. I suspect not unless there is considerable new build activity and price falls are probably overall deflationary in the wider economy.
There is definitely positive feedback between house prices and spending, both on the way up and on the way down, although the Bank of England managed to stave off the last down-leg with its interest rate and QE policies.
“As a consequence I will not be re-entering the housing market or driving down the motorway at 155mph anytime soon.” JK
Intriguing comment!
Hopefully we are not all about to be obliged to move from our homes?
Smile.
Another value measurement is to compare real (inflation adjusted) house prices, with their long-term average. Unsurprisingly the result is pretty much the same.
Expensive!
Yet another further value measurement is the rental yield obtainable. Has ranged from 4% to 10% or even 12% on occasions. Presently we seem to be around the 4% region. So again Expensive!
However it is difficult in today’s low-yield environment to better that real yield (real because rents can be expected to rise with inflation).
The Case-Shiller data is sometimes referred to by US investors as why housing is a poorer investment than Stocks. This conclusion tends to overlook the rental yield on top of house prices matching inflation.
Strikes this investor as odd that so many investors scorn using Stock/Bond Valuations when allocating their liquid investments assets, but suddenly become interested experts regarding Valuations when housing is mentioned?
Sigh!
Thank goodness for the ‘Rainbow’ riding to the rescue yet again, to show us so clearly where we are.
Hi Magneto
Obviously I agree with everything you’ve said! As for “Hopefully we are not all about to be obliged to move from our homes”: No, no obligation to move. I just exited the market in 2005 because I wanted to use the capital gains to seriously kick-start my retirement fund, which it did. And now I’m quite happy renting until the housing market returns to sanity.
I’m not sure most people realise what they are doing. The level of exposure to debt is truly off the scale.
House prices have never been about demand, but affordability. When QE blows up the economy and mortgage rates balloon there are likely to be so many repossessions, and young people’s finances will be ruined for 10 years or more.
It’s insane and it didn’t have to be this way, managed by government rigging. House prices are very likely to halve in nominal terms, irrespective of future inflation adjustment.
Hi LR, a strongly bearish case there! I’m not quite as bearish as you, but I think 50% declines in London are a very real possibility. Outside London, 50% seems too much as I don’t think prices are nearly as bonkers the further you get outside of London and other big cities. But a massive collapse in London? I think it’s very possible.
I’m a little sceptical about your assumption that incomes will rise at 1.5% in excess of inflation. You’ll have seen the IFS projections for income “growth”.
Automation, erosion of Trades Union membership and power, privatisation and globalisation have also served to weaken the bargaining power of labour and I don’t see any sign of that changing.
Therefore, if inflation increases to, say 5%, (not high by the standards of the 70s and 80s), I see incomes lagging well behind.
The BOE may also be slow to raise rates if there is a run on sterling since the fall in sterling over the since June/July 2014 from around 1.7$ to 1.24$ has not resulted in high inflation by historical standards. The government of the day during a future sterling crisis may also look to means other than interest rates to reassure the markets.
I wonder whether a drop below dollar parity would cause foreign property owners in London to start to look for the exit doors.
We live in interesting times.
Hi GOP, your point about currency is an interesting one. The top of the London market is driven by fickle foreign speculators and so the fall in the pound is probably very alarming to many of them; much more so than the actual slowdown in prime London property. Interesting indeed. Perhaps a falling pound driving foreign property speculators away and interest rates up could be the spark that lights the fuse to this particular stick of dynamite.
On the earnings growth rate, the 1.5% figure was simply a ballpark assumption based on historic averages. I agree that over the next ten years there’s a good chance that real earnings growth will be closer to zero for many of the reasons you cite.
On the currency front you maybe interested in the following http://voxeu.org/article/unwinding-pound-carry-trade, which describes a £-London house price carry trade, and discusses a potential unwinding.
Thanks Adam.
I do not think there is a high correlation between average earnings and house prices, the average earner cannot get into the house ladder, he is renting these days.
You first need to look who is buying the houses these days, how many use a mortgage and if that mortgage is based on average earnings. Only 52% of houses are bought with a significant (more than 40% LTV) mortage today.
There are people moving faster through the earnings scale than others. My income tripled in the last 6 years and it was higher than average earninngs 6 years ago. In the process I flipped a few houses too making good profits using leverage and the capital gain was not taxable because of main residence exemptions.
As in Sydney or other places in Australia, or in the US or in the UK property prices are based on offer and demand. I will argue that we have a problem with the offer side of the equation in the UK, there are not enough properties in stock or on the market.
I put my house in Dorset two weeks ago on the market and it was snapped immediately at the asking price by a retiring couple. However I struggle to find a suitable property to buy, a property closer to the school and in the right area and budget is not an issue here. In fact there are no 4 bedroom detached houses available in the area I am looking to buy. NONE.
A house isn’t just a house, it is a home. It needs to have my little office, my wife needs her little walk-in warderobe, my son needs his playroom etc. We get emotional about out little places, we fall in love with them. How can you price love?
I would not be concerned about house prices, or at least it will not be my main concern. There seem to be a new wave of foreign buyer coming in as well, but I do not like the Chinese who buy London properties with a view to keep them empty, so they are still NEW. Come on!!
The chart in the article is based on average house price to average homebuyer earnings rather than average UK earnings. However, the chart looks more or less the same in either case. Perhaps “this time it’s different”, but I seriously doubt it. History suggests that house prices are currently at bubble levels, and that bubbles do not end well, and I expect that to be the case here as well, although of course nobody can say for sure.
As you point out though, if a house is a home then price is less relevant than affordability, although I can’t say I’ve ever loved or even become emotionally attached to a house. It’s just somewhere to live as far as I’m concerned, but I guess that’s a consequence of never having lived in one house for more than ten years.
Hi John,
my first foray into house prices and I very much enjoyed your piece. Do you have advice for working out regional ‘bubbles’? I’m based in Northern Ireland and likely to stay here so I want to keep track of how things are moving?
Thanks,
Nick
Hi Nick, for a regional analysis I think your best bet is the Retirement Investing Today blog’s annual review:
Valuing the Housing of England and Wales at County Level
It’s very detailed and although it only looks at current valuations it’s easy to infer whether counties are cheap or expensive relative to history as well.
Ah, just noticed you’re in Northern Ireland, which isn’t in that article (I think)! However, the article outlines the methodology (basically get land registry or other house price data and regional average earnings) so you might be able to do the price to earnings valuation yourself.
Thank you for taking the time John, seems I will indeed need to look into it but a worthwhile pursuit!
Hi John,
Thinking about signing up to your subscription however I’m growing my portfolio at the moment. Very enjoyable to read though.
Until I can subscribe to your service I’ve taken the initiative to screen stocks myself and two stand out – Taylor Wimpey and Berkeley. I wonder where these stocks fall in your screener? They are cheap, offer high dividends and have healthy balance sheets.
HOWEVER, personally I think Value Trap is screaming out at me shortterm but then the fundamentals of supply and demand support the homebuilding industry long term. The companies look very healthy (no/little debt) so could weather a small storm but then how much of that is supported by speculative investments in land?
I’m 24 so I have some years to learn but my perspective could be useful. I’m currently renting and could afford a mortgage however I too see homes as overvalued and have opted for rent (based in East Midlands) but if they slipped to mean reversion I would be tempted to enter the market – this has to be the consensus for a lot of the youth today? Many of us have been saving for a house for 2-5 years.
How far would house prices need to drop to hit the mean reversion and how would this affect homebuilders?
Would love to here your thoughts because I think a lot of value investors are probably having the same conflicting thoughts.
Love your analysis.
Cheers,
James
Hi James, unfortunately Taylor Wimpey and Berkeley aren’t on my stock screen because they both suspended their dividends after the financial crisis (I only look at companies with a ten-year unbroken record of dividend payments). That means I don’t really have much of an opinion about them.
One thing to consider is that they are in the house building business, which is enormously cyclical. Unlike toothpaste which people will buy on a regular basis no matter what, it’s very easy for people to not buy a house when times are tough, and most people can avoid buying a house for years, which they tend not to do with other products (other than things like cars or furniture for example, which can also be enormously cyclical).
So I’m not against buying housebuilders, but you do have to think about when it makes sense to buy them, and it typically makes most sense to buy cyclical companies at the bottom of their cycle, and I’m not sure were at the bottom of the cycle for housebuilders.
But as I said, I don’t know much about those companies so feel free to ignore my pessimism!
As for mean reversion, the housing market is very regional, so how far above fair value a market is depends on where it is; so London is of course very different to the East Midlands. But nationally, I can quote from the article:
“If [reversion to fair value] were to happen tomorrow then the average house price would immediately fall to around £160,600, a decline of some £56,900 or 26%.”
Re Berkeley Group, I think you may check their annual reports/announcements on 2003-2004 where they have split into an additional class of shares with dividend paid for the period of 2004-2012, hence there is no dividend cut in the period.
This company is easy to miss from dividend screen that check for length of dividend payment
Thanks. That’s always one of the problems with screens and electronic data, they’ll miss the details if anything unusual happens.
John
I really like your rainbow analysis and analogy of 155mph drive on a motorway. Economic analysis isn’t sophisticated enough to work out when a crash will happen but it should be able to tell when it is looking pretty inevitable. Can you help me with one puzzle? Rather than analysing this all in term of house price to earnings should we not look at the ratio of mortgage payments as % of income lending as that is basis of the lending decision and long term affordability?
Thanks
Marcus
Hi Marcus, for me the problem with looking at mortgage payments is that the current multi-millennia low interest rates make a very large mortgage look affordable, because the interest payments are unprecedentedly small relative to the loan. If interest rates moved back to 10% or more, which they could easily do over the next decade or two, then it would completely shut out first time buyers at current price/earnings multiples, which would very probably force a price correction.
On the other hand, if mortgage interest rates stay below 5% “forever”, then you would be right in that payments as a % of income would be a useful metric. However, I think mean reversion to (and temporary spikes above) historically normal interest rates is more likely in the long-run, or if not then some other pressure (market or political) which brings house price multiples down to historic norms (and possibly below).
Hi John
People are talking about a recession and this will cause house prices to come down a bit, if there was one. Whether it is from interest rate rises, or over supply, or a slow down in the economy, any of this could make property prices in this country come down.. I also believe with immigration controls from brexit will also reduce prices. Less workers coming in the country, should ease some of the strain on housing, giving an effect on property demand. The UK is a relatively small country with a large population, so I don’t think there would be a great reduction in home prices, but if there were to be a recession, which maybe is likely..will stop rising home prices. I believe in the theory that home prices will remain stagnant for a while in the future. Mainly because of possible lack of growth in the economy, job security and investment in the country.
Hi James, that sounds like a reasonable theory. I also think a long (possibly multi-decade) period of house price stagnation is likely, but of course we cannot know for sure. If inflation takes off and interest rates go up then a more pronounced crash will be likely. We’ll just have to wait and see.