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Was the last fall in house prices just a warning?

The market has recovered most of the ground it lost after 2007. But pundits now fear a crash that could wipe 20% off the value of your home. Richard Northedge reports

House prices started to fall in autumn 2007, more than a year before the government had to rescue HBOS and Royal Bank of Scotland and before the rest of the economy sank into recession.

Now there are widespread fears the property market is about to turn downward again, anticipating a double dip in the wider economy.

Prices have risen 15 per cent since February last year, according to Nationwide building society, undoing much of the fall during the previous 16 months, but some economists are warning of another crash that could cut values by more than 20 per cent. Even by 2020, house prices will probably not have returned to their pre-crash levels in real terms, say some forecasters.

For those people – especially would-be first-time buyers – prevented by high prices from becoming owners in recent years, bringing purchases back to affordable levels may seem like a good buying opportunity. But the reality is that while people may say they do not want another property boom, no one wants to buy an asset that is falling in value, especially if high borrowing means a fall leaves them with negative equity.

The housing market's importance extends far beyond whether people own their homes. The Bank of England admits that housing is a driver of the economy; rising prices not only provide the feel-good factor that encourages us to spend and invest, but also givies consumers cash through remortgaging and equity release.

John Hawksworth, the head of macroeconomics at PricewaterhouseCoopers, one of the consultants forecasting an imminent decline in prices, warns: "Our econometric analysis suggests that an unanticipated future fall in house prices could have a significant impact in dampening the speed of the recovery in consumer spending in the medium term."

There are already signs that a property market that has risen steadily for more than a year has reversed. Selling prices fell last month for the first time since 2009, according to Rightmove, which surveys more than 90 per cent of estate agents, dropping by an average £1,435 to £236,000. Director Miles Shipside says: "This is the first month-on-month fall in 2010, and with the likelihood of more economic pain to come, we forecast further downward pressure on new sellers' asking prices."

The new Government is being blamed for the reverse in the market. Not only has demand to buy property been reduced by an austerity package that puts jobs at risk and which will raise VAT, the abolition of HIPs – the Home Information Packs sellers had to buy – has greatly increased the supply of properties on the market. Shipside reports a 22 per cent jump in homes on offer since HIPs were scrapped last month.

That has turned a sellers' market into a buyers' market. Instead of several potential purchasers bidding against each other for a limited choice of homes, there is now a wide variety of properties on offer but fewer people coming to view. The result is an increase this year in the average number of properties on estate agents' books from 63 to 77, while the time it takes to sell has lengthened from 63 days to 85. The ratio of sales to agents' stocks fell by 25 per cent last month, says the Royal Institution of Chartered Surveyors.

And the increase in capital gains tax announced in the Budget as well as plans to cap housing benefits is making landlords less keen to own properties, according to agents who report a fall in buy-to-let deals.

Eric Pickles, the Communities and Local Government Secretary, believes easing planning controls will make more land available for housing and will be bringing out a new Localism Bill in the autumn which will include incentives for local councils to release land for housing. And on Friday the Housing minister, Grant Shapps, said the Government will go even further in bringing life back to villages by allowing local people to decide whether new homes and shops should be built. At the moment, planning permission to build on green belt land is only granted in exceptional circumstances. But Shapps said that with the new Community Right to Build programme, people will be allowed to build any type of property on Green Belt land if enough locals are in favour. "The countryside must be a vibrant place to live, and cannot be allowed to become a museum. I want to give communities the power to preserve their villages, which are currently struggling to survive because of a shortage of affordable housing." But there will be a caveat to stop a free for all; villagers will not be able to increase a village's size by more than 10 per cent over a 10 year period. Under Shapps's new plans, local groups would be able to club together to buy land through a community land trust, with support from banks.

But, while Britain has a long-term shortage of homes,at present, supply is not deemed to be the only problem and increasing it is likely to depress prices. Not only are owner-occupiers reluctant to buy properties likely to lose value, but housebuilders will stop construction on land they already own if they see little prospect of selling the completed homes profitably. The builders are only just restoring their businesses after the slump of 2008.

The main shortage in the market is not even buyers or land, but finance. Shipside says: "The number of mortgage approvals seems rationed at around 11,000 a week compared to the consistent weekly run rate of about 30,000 newly marketed properties." Not all homes on the market will be sold, and not all purchasers require loans, but savers are still not providing banks and building societies with the funds necessary to meet demand.

Traditionally, property market trends start in London and Rightmove's survey shows prices in the capital down by 1.7 per cent last month, with only East Anglia falling further. There were increases in three of London's 32 boroughs, but upmarket Kensington and Chelsea was hit hardest with a 5.2 per cent fall. Bob Crowley, an estate agent with Bective Leslie Marsh, reports people making lower offers and more buyers withdrawing, with price reductions as sellers chase buyers for the first time in 14 months.

Roger Bootle, the long-time housing bear who heads Capital Economics, forecasts prices falling much further. He reckons they will end this year down 5 per cent, which means not only reversing the 3 per cent recorded by Nationwide in the first half of 2010, but continuing down. For next year he sees a further 10 per cent fall with the same again in 2012. That would cut prices to below last year's post-crash dip and leave them more than 30 per cent below the 2007 peak, wiping out the wealth of millions of owners and leaving them with negative equity.

At Pricewaterhouse, Hawksworth remains gloomy for even longer. He thinks there is a 70 per cent probability that prices will not return to their peak levels in real terms even by 2015, and an evens chance of prices still not reaching 2007 heights, adjusted for inflation, by the end of the decade.

Hawksworth, who uses an economic model that incorporates changes in household income, interest rates and housing supply, says: "Our analysis suggests that house prices remain vulnerable to setbacks. The possibility of a renewed fall in house prices over the next few years, particularly in real terms, cannot be ruled out as mortgage interest rates start to rise again."

Although the Bank of England's base rate is not expected to change imminently – Legal & General's chief economist, James Carrick, reckons it will stay at 0.5 per cent until 2012 – mortgage rates could creep higher as banks are forced to offer better terms to savers.

For buyers, the recent relaxation in lending criteria could be reversed if banks fear the value of their collateral is set to fall. A loan of 80 per cent of the purchase price becomes an 88 per cent loan if the property value declines 10 per cent. A double dip in the housing market will cause problems for lenders as well as borrowers, forcing banks to increase bad-debt charges at a time when they hoped to be writing back previous unused provisions.

A double dip in the property market will mean an increase in the number of repossessions. Nationwide's monthly consumer confidence index fell in June to 63, compared with 84 in February, and found that 53 per cent of the public questioned think there will be few jobs available in six months' time. The index shows faith in the economic situation at a record low, and Nationwide's chief economist, Martin Gahbauer, warns: "Consumer willingness to spend remains part of a fine balancing act with the employment situation and levels of disposable income."

Nationwide's house price figures for July, due this week, will give a clue to how the market is moving, but Shipman is working on Rightmove's next confidence analysis. "Early indications from the next survey, due out in August, suggest a swing to a more negative outlook on the future direction of property prices," he warns.

"In the April survey, before the election and emergency Budget, 44 per cent of respondents believed prices would be the same or lower in 12 months' time." Of those surveyed so far for the August survey, that has turned into a 54 per cent majority. "Consumer sentiment is a major influence on the housing market," he warns.