Why the housing market remains in the doldrums

Few buyers are rising to the bait of attractive mortgage packages. Clifford German explains

THE housing market refuses to recover, much to the mortification of everyone who paid more than they could afford for a property in the belief that it was a home, investment and private pension fund all rolled into one.

The pattern is uneven. While prices are still drifting down in the Midlands and the North, there are a few signs of a "rebound" in prices in London and south-east England. In parts of south-west London, for example, property prices are now 15 per cent higher than in 1989, although in the Docklands they are still 30 per cent below the peak.

Similar variations occur across the country. From peak to trough, property prices south and east of the line from the Bristol Channel to the Wash have fallen between a quarter and a third. North of that line prices are still about 10 per cent below the peak, while in Scotland prices of comparable properties have hardly fallen at all in the 1990s.

Across Britain as a whole, however, there has been no real recovery and property prices are still 12 to 15 per cent below the peak. This has left 1.2 million people with negative equity, owning property worth less now than the amount they borrowed to buy it.

The psychological shock to a generation of home owners cannot be underestimated. In the last 25 years there have been three vast surges in house prices (in 1972-73, 1978-79 and 1987-88), followed by three setbacks. After the first two surges property prices failed to keep pace with inflation and dropped back in "real" terms (after deducting the general level of inflation). But they did not fall in money terms, and the impact on confidence was small.

Since the last leap in prices, however, general inflation, as measured by the retail price index, has been significantly lower than on the two previous occasions, and has conspicuously failed to conceal an actual fall in property prices. Allowing for both the drop in house prices and for general inflation, prices have fallen 40 per cent in real terms.

Yet earnings have risen by almost 40 per cent since the property market peaked, and homes have become much more affordable. The average home now costs less than 3.2 times average gross annual incomes, roughly equal to the multiples seen at the bottom of the market in 1970 and 1982, and below the 3.4 multiple at the bottom of the 1977 downturn. That compares with prices more than five times average incomes at the peak of the boom in May 1989.

Even after the recent rises mortgage interest rates are still barely half as high as in 1989-90, so that the cost of servicing the average mortgage out of the average pay packet has fallen even faster than the price-to-earnings ratio. With prices down, interest rates down and earnings higher, the monthly cost of buying an average property, as a proportion of average earnings, is less than half as much as it was in 1989, and has fallen to its lowest level in 30 years.

The TSB's Affordability Index shows the average married couple were paying 36 per cent of their combined take-home pay to service an average mortgage in 1990. That had fallen to 13.7 per cent early last year before interest rates began to rise again. In the first quarter this year it was still only 14.9 per cent. For first-time buyers the percentage was just 12.5 per cent of their combined take-home pay in the first quarter of 1995, down from 34 per cent in 1989.

But prospective buyers are just as unhappy as owners, and reluctant to commit themselves to buy, even at what look like bargain prices. Sellers seem convinced that prices are about to recover; buyers are determined to wait for even better bargains; and turnover remains barely half the 1989 peak of 2.4 million transactions a year. The only people who seem to be happy with the course of events are at the Bank of England, which has been carrying out a campaign against mortgage tax relief for at least a decade. It claims that inflated house prices create windfall profits that fuel surges of inflationary spending and distract investors from their proper job - investing in stocks and shares for the benefit of industry and government.

Efforts to stop home owners borrowing more money on the back of inflated property values to finance inflationary consumer spending simply failed to stick. But by reducing inflation and raising real interest rates (that is, actual rates less the rate of inflation) to the point where they really hurt, the Bank has succeeded with a vengeance.

The Treasury has proved a willing ally by holding the ceiling for mortgage interest tax relief unchanged at £30,000 for a decade, eliminating tax relief at the higher rate, and then cutting basic mortgage tax relief from 25 per cent to 20 per cent and now 15 per cent. This month alone the Treasury has reduced the tax saving on a £30,000 mortgage at 8.34 per cent interest from £42 a month to £31 a month.

The plan to make home owners who lose their jobs wait nine months before their mortgage interest is paid will also panic home owners and make them even more reluctant to take on extra debts. And when unemployment next begins to rise it will increase the flow of home owners whose properties are repossessed and dumped back on the housing market for whatever they will fetch.

It is hardly surprising that house prices are still static and the long- predicted recovery now looks as far away as ever. Yet the mortgage market offers more choice to more borrowers than ever before. Lenders are desperate to win business. Borrowers are bombarded almost daily with new and special offers of cashbacks, reduced interest rates for anything from six months to three years and free or reduced legal and survey fees. Special deals could genuinely save them thousands of pounds if they buy a property for the first time, move, or simply remortgage from one lender to another.

The problem is partly the sheer variety of special offers, which has created so much choice that it is actively confusing borrowers. A survey from the TSB shows that 61 per cent of borrowers are suspicious of the offers available and afraid that it would cost them too much in charges to switch to a better deal.

But borrowers are not just spoiled for choice. They are increasingly worried by the continuing attacks on the housing market mounted by the Treasury. The cut in mortgage tax relief from 15 per cent to 10 per cent, which took effect on 6 April, only costs the average borrower another £3 a week in extra tax, but borrowers now accept that mortgage tax relief will be phased out entirely over the next couple of years.

It also comes at a time when interest rates have risen and the Chancellor and Governor have been making great play of their resolve to raise rates again and again if necessary to reinforce the fight against inflation.

The rise in interest rates over the past year has killed off the rally in the housing market that seemed to have started early last year. And sensible borrowers well know that there is little chance of the Chancellor coming to their aid with selected tax concessions either before or after the next election.

It is a depressing picture for a market that played a vital role in all previous recoveries and propagated the feel-good factor that helped keep the Government in power for 16 years.

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