Property prices - high and rising

Last year saw UK house prices rise on average by 11 per cent. But how long can the boom go on, asks Clifford German

Most homeowners in the UK made more money last year out of increases in the value of their property than they did out of windfalls from building societies converting into banks. The price of privately owned homes went up by pounds 4,300 each, creating pounds 50bn of extra value, compared with pounds 30bn worth of windfalls from the Halifax and other building societies and insurance companies that issued free shares to members.

This year the rise in house prices is expected to slow down from 11 per cent to 6 per cent, according to research by Cambridge Econometrics, but it will still be a nice little earner for homeowners, especially now the flood of windfalls has slowed to a trickle. Next year should see a further 6 per cent rise in properties. Regional differences will narrow after the surge in London and South East England during 1997, but London and the South East will still see rises slightly greater than the national average, although the level of activity in the housing market will fall in London as properties are priced out of the reach of buyers.

Confidence in the housing market has been maintained by falling unemployment, in spite of rising interest rates. In fact, the Bank of England's efforts to cool the housing market down by raising the base rate five times last year has been completely thwarted by the fall in longer-term interest rates, and the speed with which borrowers have switched from variable rate mortgages to cheaper longer-term fixed rate mortgages, according to Peter Spencer of Birkbeck College London and economic adviser to Ernst and Young.

While base rates have risen to 7.5 per cent, and the standard variable mortgage rates charged by the leading bank lenders have increased to 8.7 per cent over the last 12 months, the cost of a five year fixed rate mortgage has come down from 7.39 per cent to 5.89 per cent. Meanwhile, the proportion of new mortgages taken out at fixed rates has rocketed from little more than 20 per cent two years ago to an estimated 60-65 per cent in the first quarter of 1998. A further 10-15 per cent of new mortgages are at variable rates, capped at a maximum rate, usually 6.99 per cent for the next two or three years.

Even allowing for lenders' fees, legal and surveying costs and removal charges, fixed rate mortgages have held down the cost of moving home, and the rise in base rates has had little or no impact on the housing market. The number of properties changing hands is likely to reach 1.5m, the highest level in almost ten years, and house prices will rise by a further 8 per cent this year, according to Mr Spencer.

How long will the housing boom last? It will come to an end, as the three previous booms in the early seventies, late seventies and late eighties came to an end, especially as inflation is not there to cushion the impact of a fall in prices. When the economy slows down and unemployment starts to rise, confidence in bricks and mortar will decline. But the chances are it will not crash as it did in the early nineties, because interest rates are less likely to rise sharply.

Yields in the gilt-edged market may fall further if the PSBR remains in surplus, and fixed rate mortgages may come down more if the UK applies to enter the EMU, according to Mr Spencer. But UK lenders may have to offer fixed rate mortgages for ten years or more if they are to compete with European banks entering the UK mortgage market.