A dose of reality on house prices

28 November 2011 | By Eric Stoclet, chief executive officer of Crown Mortgage Management

Mention house prices and you are sure to start a lively conversation. With 67% of the population owning their home and with a substantial piece of their savings tied into home ownership, it is no wonder.

From 1953 to 1999 prices rose at a compound annual growth rate of 8.2% per year, according to Nationwide. From 2000 to their 2007 peak, prices more than doubled, rising 155% or the equivalent of a compound annual growth rate of 12.4%. Since Q3 2007, house price inflation has been close to 10%.

To understand what direction prices will head in, one has to ask what caused the 2000 to 2007 ramp-up. Politicians have suggested it was mainly due to a lack of housing. The implication is that prior to 2000 this was not the case and that a population boom, which started in 1999, put pressure on available stock.

That thinking ignores the overriding role played by cheap, readily available finance, which gained momentum in 1999. Coupled with a benign regulatory environment, this allowed a boom in mortgage financing, with average balances per household going from £20,500 in 1999 to £46,000 in 2007. Cheaper financing and easier terms allowed people to buy more houses with less pressure on their finances. This put pressure on housing stock in terms of price and availability as people who had previously not had access to finance became eligible.

Now financing has dried up and one could question whether new origination will ever regain the levels seen in 2006/07, given the damage sitting on banks’ balance sheets, regulation, over-leveraged consumers, a harsh economic environment and chaos in the eurozone. Less financing will continue driving prices down, in particular coupled with an eventual rise in interest rates, which will put pressure on borrowers.

Even the strong showing of London and the South-East might weaken. With higher capital requirements and increased regulation, banks will have to revise business models. The costs and the need to exit unprofitable business are likely to impact not only staff levels but also pay. Large bonuses will not disappear, but they will be available to fewer people. Total bonuses in the City peaked in 2007/08 at £11.6bn and 2011 bonuses are expected to total just over £4bn.

London has also been viewed as a safe haven, benefiting from the uncertainties resulting from the Arab Spring and the eurozone debt crisis. For historical reasons and because of the UK’s political stability and robust legal system, London is not likely to lose its safe haven status. But that may not be enough to offset the downward pressure on house prices that changes facing the financial services industry are sure to exert.

The outlook for prices is far from rosy but expecting anything less is to believe that one can get over the massive over-leverage generated in the last 10 years by wishing it away.

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