What’s happening to house prices? The Nationwide is likely to report next week that they’ve risen by around 1 per cent in the past 12 months. Even this, though, might overstate the strength of the market.
To see why, consider what happens to prices when demand tends to fall. In theory, they could immediately drop to attract new buyers, with the result that it is prices rather than volumes that respond to lower demand. This, however, does not happen in the housing market. Instead, sellers either hold out for high prices ('my house is worth more than that') and so don’t see their property sell; or they take it off the market; or they don’t put it on in the first place.
This means that price indices are upwardly biased when demand is weak, because it is only the best properties that sell. The Nationwide’s index measures prices at the time that mortgages are approved. This means that if a potential buyer walks away because asking prices are too high, no approval occurs so no price is registered. It also means that reported prices don’t capture 'gazundering', when a buyer demands a lower price than previously agreed – a phenomenon that seems to have re-emerged recently.
Of course, this cuts both ways. When demand booms, price indices are downwardly biased because then even rubbish is selling. And it applies not just to housing but to all markets where sellers have reservation prices, such as in antiques or art.
Nevertheless, it has some important implications. One is that, over time, prices are more volatile than headline indices suggest. Yale University’s Will Goetzmann has estimated that prices in Los Angeles are one-third more volatile than standard indices imply. Applying this to the Nationwide’s index suggests that the chance of prices falling 10 per cent or more over a 12-month period is three times as high as the index would suggest (around 6 per cent versus 2 per cent).
Which means of course that housing is a riskier investment than reported data imply. In fact, this is true in two other senses as well. One is that none of us holds a representative bundle of houses but (usually) just the one. And just as individual shares are riskier than the All-Share index, so individual houses are riskier than the index. The other is that a market downturn doesn’t just see house prices fall but also sees liquidity dry up. That’s catastrophic for anybody needing to raise cash quickly.
We have mixed signals on how big a problem all this is right now. Certainly, demand is weak. The Royal Institution of Chartered Surveyors (Rics) reports a “sustained fall in new buyer interest” and figures from the Bank of England next week could show mortgage approvals at their lowest level since December 2017. The Rics also reports a drop in the number of people putting their homes up for sale, which implies there might be a selection bias causing prices to be overstated, to the extent that it is lower-quality properties being withheld from the market. But on the plus side, it has found that vendors have just recently become more realistic in their asking prices.
Net, though, it’s very possible that the housing market is weaker than headline numbers suggest.
