Freeze house prices for the next five years, a think tank demanded this week, but to return to ‘fair value’ property prices would need to fall 30 per cent.
An IPPR report into the UK’s imbalanced economy laid out a number of proposals, but the real eye-catcher was that the Bank of England should act on high house prices.
It said the Bank should limit mortgage lending, triggering a five-year house price freeze and allowing wages to start to catch up.
House prices have trebled since 1991, as Nationwide’s data shows, and spent many years rising faster than wages
The report’s author Grace Blakeley said this could ‘reset expectations and allow affordability to improve’.
After that initial period, it should target house price growth of 2 per cent – the same as its inflation target.
Yet, even in the unlikely event this policy is adopted, Britain is in such a property pickle that a five-year house price freeze wouldn’t achieve much.
If wage growth over the next five years averaged out at 2.5 per cent, ONS average earnings would grow by 13 per cent, from £27,000 to £30,500.
If the average ONS UK property value froze at £227,000 this would take the house price-to-earnings ratio down from 8.4 now to 7.4 then.
Houses would still be very expensive by historic standards.
Nationwide’s monthly report uses a higher household average earnings figure of £37,000 and has a lower average house price at £214,000. Yet even it shows a current house price-to-earnings ratio of 6, compared to a 30-year average of 4.2.
For house prices to fall back to that fair value level they would need to decline by 30 per cent – dropping £64,200 on average.
Alternatively, if house prices stagnated earnings would need to rise by 38 per cent.
Of course, neither might happen. Perhaps the theory of mean reversion, where the valuation of assets eventually return to the average, doesn’t apply here. Maybe, our brave new world of low interest rates means that things really are different this time and it’s not wages that matter but the affordability of mortgage payments.
My suspicion is that isn’t the case, however, and that we will eventually revert to the mean of wages vs house prices, but that it will take much longer than would otherwise be expected.
Nationwide’s figures show house prices would need to fall 30 per cent to go from the current ratio to household earnings of 6 to the long-run average of 4.2
If house prices did take such a tumble, mean reversion theory says they should fall further, as prices tend to overshoot at both ends before returning to the long-term average.
In the last slump after the financial crisis that didn’t happen, as the decline was arrested by a lack of forced sellers, thanks to super-low interest rates, money pumped into the system, and heavy pressure on banks and building societies not to repossess those in mortgage arrears.
This was clearly good news for those at risk of losing their homes, which people who suffered in the 1990s crash will tell you can have a long devastating effect.
The cost of avoiding the tough medicine, however, is our problem now, where both nationally and locally homes are expensive compared to average wages.
This has been exacerbated by throwing money at the wrong side of the problem, with schemes such as Help to Buy. Instead of making houses cheaper to build and sell, we have given people more money to buy them.
This is a particular issue as we don’t build enough new homes and evidence shows that in the current UK system building more doesn’t bring down house prices, as they are sold as a premium product priced against existing homes on the local market.
The IPPR report itself cites a study
There are two opposite paths you can follow with such things, a free market or a command economy.
The IPPR proposal veers towards the latter, while I suspect many of our readers instinctively prefer the former.
At the moment we are stuck with a weird economic third way, claiming the free market is best while meddling with and propping up the housing market at the same time.
I suspect, one day that will end though. There’s not much more we can throw at supporting house prices and at some point they will have to correct.