The teetering tower block
The housing bubble that inflated between 1996 and 2007 was possible thanks to cheap, plentiful credit. And when credit became dear and scarce, that bubble began to implode. Although official interest rates are now at their lowest level ever, the banks are either too scared or not actually in a position to lend. Of the few mortgages being granted, most are going to borrowers with substantial deposits.
Lately, the decline in the number of new mortgages being granted has slowed. This could lead to a slowing in the rate of decline in house prices. However, even if it were to turn positive, that wouldn't necessarily boost the housing market all that much. Year-on-year mortgage growth recovered to mildly positive levels around the mid-way stage of the last housing price crash, but home prices kept on falling.
Rising unemployment is likely to undermine the housing market further over the coming year. Economists believe that joblessness will worsen substantially into 2010. More homeowners will default on their mortgage payments, making banks more reluctant to create fresh loans. And with fewer people seeking to relocate for work reasons, housing demand will remain weak.
Past experience also tells us that the end of the recession will not mean the end of the housing slump. Whereas economic downturns generally last six months to two years, the average British house price crash has grinded on for roughly five years. The last recession ended in late 1991, but the value of bricks and mortar continued to deteriorate for another four years.
The current housing crash feels very similar to that of the early 1990s. After allowing for inflation, prices have fallen by a similar amount by the equivalent stage. Back then, prices were down 17.5 per cent after five quarters of the crash. This time round, they were down 18.1 per cent.
Intriguingly, each quarterly decline has been of roughly the same size. So what if the present meltdown continues to follow the same path as its predecessor? Were prices to fall at exactly the same pace throughout, we are still a very long way off the bottom. The last housing price crash lasted 26 quarters: six-and-a-half years in total. That would imply that it might not be until at least 2013 that prices stop declining.
Of course, if prices follow the same course this time round as they did back in the early 1990s, the market might still be overvalued. Let's say that real wage growth also follows the same path that it did during the last house price slump. By early 2013, the price/income ratio would still be 3.46 times. To get it back to the level where it ended at the milder crashes of the 1970s and 1980s could take until 2015.
However, this does not seem the likeliest scenario. Price falls are likely to be faster than they were last time round as the present slump progresses.
Valuations have only fallen to 1989 peak levels
UK houses are still very overvalued. Using the Nationwide index, the average price as of February cost 4.8 times the average British salary. Admittedly, that's a lot lower than the all-time record multiple of 6.4, reached at the top of the bubble in 2007. But, to put things into perspective, the housing market's valuation today is now at the same level as it was at the height of the 1980s boom. In real terms, house prices fell 37 per cent from that point last time round.
At the end of the last three housing crashes, the average house price/income ratio was 3.2 times. And at the end of the most severe of those episodes – in 1995 – the multiple was a mere 2.8. Going back to the 1960s, the average ratio is 3.9 times (see chart, below). Whichever one of these ratios we use, there is clearly plenty of scope for a big fall in prices in order to bring valuations back down to earth.
Houses could still fall by one-third
Let's imagine an optimistic scenario where the price/income ratio returns only to its long-term average. We'll also assume that prices continue to fall at the rapid pace they have over the past six months and that salaries continue to grow at the rate they have over the past decade. If this happens, the market could bottom later this year, leaving the average UK house worth £137,400 in today's money – compared with £147,746 now, and £184,000 at the top of the market.
But this is probably unrealistic. At the very least, it seems likely that valuations will return to 3.2 times and that wages will grow at much slower rates than they have over the past decade or so. Assuming that rapid price falls continue, the UK housing market might reach a trough some time in the middle of next year, leaving the average inflation adjusted price at around £127,000.
But there's also a good chance that things will turn out to be much worse. Let's consider what would happen if valuations plunge to their mid-1990s lows. At the same time, assume that wages grow at recent rates and that the rate of price decline slows. In this scenario, a bottom might only occur in the spring or early summer of 2012, with the average UK house costing little more than £100,000.
Inside the condemned building
While national figures give us a good feel for the state of the market overall, they don't tell us much about what we really care about: what prices and valuations are doing where we live.
Based on Halifax price-to-income ratios at the end of 2008, the areas that are dearest in relation to their long-term average levels are the North, Wales, Northern Ireland and the West Midlands. However, valuations in a crash tend to over-correct. So it might be more realistic to look at today's ratios compared with their levels at the end of the last slump.
On this basis, the picture is pretty similar, although Greater London also figures among the most over-valued regions.
Early crashes don't mean early recoveries
Just because a region slumps early or later than average doesn't mean it will follow the same pattern in recovery. The north of England was slower to crash last time round, but came out at the same time as the wider market. And East Anglia started feeling the pain earlier than the rest of the country in the 1980s, and kept suffering for longer than most other areas.
Nor does the scale of the preceding boom tell us much about the timing of recovery. The biggest boom-regions of the 1980s – which were in the south of the country – did not emerge markedly sooner or later than the regions that experienced more moderate expansions.
On a national view, the current crash began in the third quarter of 2007. The slump in the North west, Yorkshire and the West Midlands began several quarters early, while Scotland began declining one quarter later. However, we can't properly make any useful predictions about when these regions will revive, based on history.
