Time to reflect on house price booms

Old trends in the housing market are rediscovered and paraded as if they have neve been seen before
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MARSHALL MACLUHAN, the Canadian media guru, once memorably wrote that "people tend to drive into the future looking into the rear view mirror of the past". Writers on the British home ownership market seem to suffer instead from historical amnesia or windscreen vision. Rather than being fixated on the past they tend to ignore it. As a result, old trends are rediscovered and paraded as if they have never been seen before.

Trend number one is that rapidly rising prices lead to very small properties in prestige areas of central London fetching large sums of money. Roger Bootle terms this the broom cupboard phenomenon.

Trend number two is the discovery of property hot spots (now known as golden post codes), in desirable areas where incomes are high, supply is short and competition is fierce.

Trend number three is that the house price boom in London and the South- east leads to a widening North-South gap in house prices. This is happening, but it has occurred in each of the last three major booms (1970-73, 1978- 9, 1983-88). Each boom has been led by a sharp rise in prices in London and the South-east and a widening North-South gap. Hence the plethora of "London home will buy Scottish estate" stories.

What tends to be overlooked (particularly by southern journalists) is that when prices in the South-east slow up or stagnate, prices tend to keep slowly rising in the North and the periphery for a few years. As a result, the North-South gap is cyclical. In the early stages it widens, then it narrows once again. At present it is widening rapidly and price inflation in London is four times that in the North (12 per cent to 3 per cent).

Trend number four is the most obvious one: that there are cyclical booms in house prices. When demand begins to rise, usually because of rising real incomes and low mortgage interest rates, prices rise slowly as supply is broadly fixed. Prices then rise to a level where many potential buyers are priced out of the market, initital mortgage payments take a large slice of income and affordability falls. The steam goes out of the market and prices stagnate or fall in real terms, and the house price income ratio returns to lower levels when the cycle is ready to begin again.

The big question, of course, is what triggers booms in the first place. The answer in Britain is demography or, more precisely, the lagged effect of early birth rate booms, combined with a relaxation in fiscal or monetary policy and rising real incomes. The first major housing boom in 1970-73 reflected the rapid rise in birth rates in 1946-50 which hit the housing market 25 years later aided and assisted by the "Barber boom" of cheap money.

The plug was pulled in November 1973 when the Bank of England, alarmed by the rapid rise in inflation and property prices, raised interest rates by 5 per cent in one go. Much the same happened in 1979 and again in 1988, when the "Lawson boom" was terminated by rising interest rates in an attempt to get inflation under control.

What made the 1990s slump so dramatic and so unprecedented was that prices fell sharply in both cash terms as well as real terms. This was the era of negative equity and repossessions: almost half a million households lost their homes between 1990 and 1998. In London and the South-east prices fell by 30 per cent in cash terms and even more in real terms by the mid 1990s, and the volume of housing market transactions fell to almost half the level of the late 1980s.

In the aftermath of the 1990s housing market slump some observers suggested that it marked the end of the boom and bust cycle in the British housing market. The impact of the slump on homeowners' expectations of rising property prices was thought to be so dramatic that henceforth owners would see their properties purely as a place to live and not as an appreciating asset. Combined with the "end of inflation",this would lead to a new, more stable, property market where prices would rise only slowly. I doubt it.

Although we do appear to be in an era of stable low inflation, and there are no more demographic booms on the immediate horizon (the predicted size of the 23-25 age group will reach a low point in 2001), new household formation is continuing apace as the number of one-person households grows. The Government predicts a need for 4.4 million new homes over the next 20 years. Housing also tends to be income elastic. As incomes rise, people are willing to spend a higher proportion on housing.

The house price slump of the early 1990s had the beneficial effect of making houses more affordable relative to incomes than they have been for 30 years. House price-income ratios have fallen from the 5.0 of 1988 to around 3.5 on a national basis. The result is that there is considerable scope for house prices to catch up with incomes and we are already seeing this happen.

According to the Halifax, annual rates of house price inflation in the second quarter of 1999 reached 6.6 per cent nationally and 12 per cent in London. The Nationwide and the Land Registry also report sharp rises in London. The recovery may be slower and less marked this time, but recovery there certainly is.

Finally, houses are still assets, and like all assets they are prone to asset price bubbles. Once people realise that prices are rising rapidly, and that they may be priced out of the market, or be unable to make the move up-market they have desired, prices will be bid up and building society advances will begin to reach record levels once again.

The Bank of England hopes that this time around the mortgage lenders will exercise a little more restraint, and not be quite so ready to give 100 per cent mortgages at up to four times annual income.

However, competition for market share is fierce and there are reports that at least one lender is willing to lend over 100 per cent of the purchase price. Unless this is halted it may have the same result as the late 1980s: buyers will be tempted to take out mortgages they cannot afford (or can only afford if interest rates stay low). Then, if there is an economic downturn and a rise in unemployment, repossessions will start to climb once again.

The Bank warned about overheating in the 1980s but it was ignored until it was too late. Let us hope it does not happen again. It is always worth a look in the rear view mirror before overtaking.

Chris Hamnett is Professor of Geography, King's College London. His book Winners and Losers: The Home Ownership Market in Modern Britain is published by Taylor and Francis, 1999.