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Housing green shoots to die

Created:

6 April 2009

Updated:

9 April 2009

Written by:

Chris Dillow

In the last few days, some green shoots have appeared in the housing market. The Bank of England has reported a rise in mortgage approvals, and the Nationwide Building Society says that prices rose 0.9 per cent in March. These green shoots, however, are likely to die. The chances are, house prices will continue to fall. I say so for four reasons.

First, the level of mortgage approvals is still so low as to predict a fall in prices. Since January 1994 there has been a decent correlation (0.46) between the level of approvals and the change in house prices in the following 12 months. If this relationship continues to hold, Lloyds Banking Group's index of prices (the old Halifax index) will fall another 8.5 per cent over the next 12 months, with a less than one-in-six chance of it rising.

Of course, historic relationships could break down. But this is little comfort. If anything, prices have recently fallen even further than mortgage approvals would predict.

Second, house prices are still high. Lloyds estimates that the ratio of house prices to earnings is 8.5 per cent above its post-1983 average, and 16 per cent above its 1983-2004 average. The ratio of prices to rents is 27.6 per cent above its 1987-2004 average.

Of course, such fancy ratios were sustainable when banks were lending six times incomes to any customer who didn't dribble on their carpets. But when finance is tighter than average, you would expect these ratios to be below average. As for why they aren't, this brings me to...

Third, we are in the calm of the storm now. A look in any estate agent's window will tell you that the supply of houses is low, which is holding prices up. But this will change over time, as the unemployed and distressed buy-to-letters become forced sellers. This will press prices down.

Fourth, history shows us that housing bubbles deflate slowly. House prices aren't like share prices. It takes a long time for them to move. It took six years for house prices to fall after the 1989 bubble. And a study (pdf) of past financial crises around the world by Carmen Reinhart and Ken Rogoff estimates that the average crisis sees prices fall a real 35 per cent over six years. This suggests prices have another 15 per cent to fall.

There are, therefore, powerful reasons to think the housing market will stay weak.

Let me try to calibrate how powerful these seem to me. I can easily believe that the recovery in GDP will come any time between this summer and next summer. I wouldn't be at all surprised to see the FTSE 100 move 1,000 points in either direction before the end of this year. I can even - just about - think it possible that big government borrowing will cause both much higher gilt yields and a run on the pound. But a recovery in house prices while unemployment is still rising, and before the rest of the economy recovers, would be a bigger surprise to me than any of these possibilities.