Why House Prices Are Likely To Fall

Why House Prices Are Likely To Fall

Author: Richard Pettinger

Some commentators have been predicting house prices falls in the UK for several months. But the renewed house price growth in the UK this year inevitably raises the question of whether house prices have to fall.

There are various reasons to suggest that house prices are overvalued and likely to fall.

1. The ratio of house prices to incomes has risen to an all time high. In the UK the ratio of house prices to incomes is 50% higher than the long term average (1975-2005) The effect of this is that house prices are becoming unaffordable. It is increasingly difficult for people to be able to buy a house. This leaves the housing market in a vulnerable state.
2. It is becoming increasingly difficult for first time buyers to get on the property ladder. This is mainly due to the rise in house price to earnings ratio. However to some extent this problem has been got around by banks being willing to offer bigger mortgages compared to salaries. The Abbey National recently said it would lend 5 times a borrowers salary. Banks are also considering mortgages over a longer period. This increased generosity in lending has helped to keep the market buoyant without addressing the underlying problem of overvalued house prices.
3. For those who believe house prices can never fall it is worth remembering the case study of Japan. In the 1980s there was a similar boom in house prices in Japan. But since the peak of 1991 house prices in Japan have fallen for 14 consecutive years. Leading to considerable economic problems such as lower consumer spending.
4. Traditionally the view of the housing market is that it is not just an asset but a place to live. Therefore unlike the stock market house prices won’t rise and fall due to speculation. However a lot of demand for UK housing is coming from buy to let speculators. Firstly private rents are buoyant. This is due to rise in number of households and buoyant house prices. Also many speculators are fixed on the idea that house prices are only likely to rise. If there was a fall in either renting incomes or the first sign of house price falls. These speculators would be likely to leave the market causing a significant drop in demand.
5. The UK housing market suffers from severe supply constraints as a % of the total housing stock. The number of new houses built is very small. Therefore and change in demand magnifies any change in price. It only takes a small rise in demand to increase prices. But similarly it could only take a small fall in demand to cause significant price falls as in 1991.
6. There are record levels of consumer borrowing in the UK. This is a combination of mortgage borrowing and personal debt like credit cards. Therefore even a modest rise in interest rates could have a very adverse effect on consumer confidence and spending. Therefore the housing market is particularly vulnerable to any rise in interest rates that may occur.
7. Many economists predict significant house price falls. For example Mr Calverley, argues in his book, 'Bubbles and how to survive them', that house prices could fall by 50%. Former advisor to Gordon Brown David Miles also predicts falls in house prices. He points that much of the rising demand for housing is speculative

“However, one third to one half reflects changes in expected house price inflation - that is a speculative element of demand, which is likely to be volatile," the report said.

Therefore house price falls are necessary for the housing market to readjust.

Richard is an economics teacher in Oxford. Richard has written many articles on economics and the UK housing market. He edits a website on guide to UK Mortgages This offers advice on different types of mortgages and the latest movements in UK housing market