The price comes down and down
Do you like your house? It will probably never again be worth what it is now. Douglas Wood on the economics, Anne Spackman on the practical effects
Tuesday 23 May 1995
Given that real house prices have been static or declining for long periods this century, this view would appear to owe more to what happened in the Seventies and Eighties than any longer-term wisdom. There is still widespread reluctance to accept that events during these two decades were due to factors not to be repeated.
The world we are living in now bears no relation to the inflation-ridden Seventies or to Mrs Thatcher's debt-driven boom of the Eighties. House prices that struggle to hold their value in nominal terms and are slowly shrinking in constant money terms seem a much more likely prospect than any resumption of the boom.
The abolition of exchange controls in 1979 meant that savers would never again be forced to deposit their funds in UK banks and building societies offering returns below inflation. Interest rates now have to attract savers in a global market which requires four or five points above inflation. Since interest rates well above inflation are a central plank of government economic policy, it is inconceivable that the cheap money policies that fuelled the Seventies explosion can recur.
Nor will the explosion of credit unleashed by financial deregulation in the Eighties happen again. Then banks and insurance companies flooding into housing finance touted for business by offering ever higher valuations as the basis of their loans, thereby presiding over a doubling of mortgage indebtedness as a proportion of GDP.
Not only did this flood of money push up prices directly, but the expansion of the financial sector itself created a massive and artificial demand for housing. By the end of the decade financial services were employing almost one in six of the working population, and giving them subsidised mortgages and favourable borrowing multiples. Nowadays finance sector employees enjoy no such special advantages.
With hindsight the Thatcher miracle appears to have consisted of little more than a massive debt explosion. Without this the real economy of the UK would have shown slow growth throughout the Eighties and we would, as a result, have less fallout now in terms of negative equity and over- indebtedness.
The housing market in the Nineties and beyond will not be rescued by inflation and negative interest rates or by a credit explosion, nor will it be helped by the dwindling value of what remains of tax relief. The cumulative effect of all this is a massive increase in the real cost of buying a house. In the Seventies and Eighties the total payments in constant pound terms involved in buying a pounds 100,000 house were around pounds 75,000. The equivalent purchase now would cost pounds 130,000, leading inevitably to a major reduction in demand. Purchasers could once buy the houses they would like, with a massive discount at the expense of savers and taxpayers. Today they are buying the houses they need.
These are not the only significant changes. Lifetime employment with predictable promotion on age-related salary scales is a thing of the past. As a consequence, the logic of accepting a major sacrifice in living standards now to buy the biggest possible house, in the confident knowledge that it will be affordable in five years time, has evaporated. In the new world experienced professionals at the top of the scale are regularly axed to make way for cheaper, younger replacements who are often offered only short-term contracts.
A further problem is that the full-time, well-paid and permanent jobs which are the mainstay of the housing market are being replaced by part- time work and self-employment, in which mortgage eligibility is poor or non-existent.
The other big change is the progressive dismemberment of the planning process as financially strapped councils back away from contesting appeals by developers. The prospective availability of sites from a privatised British Rail and a shrinking defence establishment, and a massive amount of unused industrial land, means that new housing growth cannot reverse a continuing decline in site values.
Even property hot-spots which often lead the market upwards are now threatened by global electronic communications that establish Skelmersdale or even Bangalore as alternatives to London housing.
For these reasons stagnation, with the house market struggling to hold value in money terms and slipping slowly in real terms, seems the most likely prospect. Indeed, this describes the market as it has been for the past five years, despite the frequent signs of revival detected by the professionals involved in the industry.
What factors could prove this forecast of stagnation wrong? Restoration of tax giveaways would change things, but this is extremely expensive for governments and against long-term policy. A return to hyperinflation might prompt a rush into real assets, but it would have to be a world- wide phenomenon to be effective. Growing incomes may eventually lift the market but this is still some way off. Another possibility is the increase in the number of households, though it is difficult to see expansion in single-parent households, divorcees and elderly people as a source of major buying power.
Finally, are weak house prices a problem? Not really. Cars lose value quickly but are bought because they offer value to users. Just as the prospect that we could all become rich by selling houses to each other is nonsense, so is the argument that we would get poorer if prices go down. If it helps to stabilise wages and improve international competitiveness, house price deflation could be just as positive an influence on the UK's economic performance as our exit from the EMS, against overwhelming expert advice, has proved to be.
Douglas Wood is professor of banking and finance at the Manchester Business School.
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