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Are we heading for a house price collapse? Matthew Warburton - 30/05/2014

bubbles_300Last week Mark Carney, Governor of the Bank of England, said he regarded the booming housing market as the "biggest risk" to financial stability and the long term recovery of the British economy.


He expressed concern about the rise of large-value mortgages which might lead to a debt overhang that could destabilise the economy, and suggested that the Help to Buy should be overhauled to reduce the risk of it driving a housing bubble. The fundamental problem, he said, was that we are not building enough new homes.


House prices have resumed their historic place as top dinner party conversation topic, in London at least, and there has been widespread discussion in the media about what might be done to cool the housing market and slow the rate of house price increase.


Banks are already taking steps to toughen the rules on mortgage lending, but there have been suggestions that there should be even tougher limits including a return to maximum mortgage to income ratios of 3 to 1 and maximum mortgage terms of 25 years. But, some commentators have argued, this will be of limited impact since, currently, a third of house sales are to cash buyers.


And in London, where prices are rising fastest, there is a popular view that they are being driven up by overseas cash buyers looking to speculate in property they have no intention of occupying for more than a few days a year, if at all. 


One scenario for the future is that the bubble bursts leaving thousands of owners in negative equity saddled with mortgages they will struggle to repay. It has happened before. Between the summer of 1989 and the first quarter of 1993 average house prices fell by 20 per cent, with the fall in London being even greater, with nearly a third wiped off house values in the same period. The pattern since 2008 has been different.


Nationally, house prices fell by around 14 per cent in the 18 months to mid-2009, but London was less affected than other regions, and prices in London started to rise again sooner and faster than the rest of the country. Currently, average prices nationally are rising at around 10 per cent a year, but this is heavily influenced by the high rate of increase - 18 per cent - in London, and disguises wide regional variation. For example, London prices in January 2014 were 20 per cent higher than in January 2010, while in the North East they remain 10 per cent lower.


So, why is London different this time around? A popular theory is that prices are being driven up by foreign cash buyers. But such purchases are largely confined to what the estate agents call London's Prime Central markets, which represent only 7 per cent of sales.


According to Hamptons International, 60 per cent of buyers in the Prime Central areas in 2013 were foreign and 60 per cent bought with cash. Cash purchasers - but not foreign ones - have also played a greater role in other areas, being responsible, again according to Hamptons, for 70 per cent of the uplift in sales in 2013, in which year cash purchases accounted for a third of all sales.


The region with the greatest proportion of cash purchases was the South West - 39 per cent - compared with only 24 per cent in London, providing further evidence that London prices rises are not primarily driven by speculation. Many cash buyers are buy-to-let investors, but an equally, if not more important group of cash buyers are downsizing owners looking to move to smaller or cheaper accommodation, often in the country or by the sea, as sales in the South West suggest. 


This evidence tends to undermine the theory that the housing market and London in particular would be immune from measures to rein back mortgage lending. Downsizers need someone to buy their property, and at the end of each chain of purchases there is likely to be a first-time buyer dependent on a mortgage for a substantial part of the price. In a recession it is not just house prices that fall, so does the volume of sales. Existing owners, including potential downsizers, sit tight and wait for better times unless death, divorce or financial catastrophe overtake them and they are forced to sell.


A more plausible explanation why London prices have been so buoyant compared with the early 1990s rests on two facts. The first is that London's population is growing faster now than 20 years ago, and much faster than the rate at which new homes are being completed.


The second is that interest rates have been held at a historic low for the last 5 years. Compare the situation 23 years ago when Britain's entry to the European Exchange Rate Mechanism - and early exit - triggered the spike in interest rates that sent prices into freefall. Which leads to the question whether the long-expected hike in interest rates - which Mark Carney has said may come before the General Election next year - will be the pin that pricks London's bubble.


Some lenders have hinted that they have already adjusted their lending policies to anticipate the expected increase, and the Nationwide Building Society claimed that the London market is heading for a "natural correction" with a slackening in sales already underway. The Society took pains to say they are not predicting a widespread slump, but then, they would, wouldn't they. Future housing market trends are probably more uncertain than for some years. It makes sense to consider several possible scenarios and their likely impact, not just on the future of the private market, but the repercussions for social housing, too.

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