When Will House Prices Finally Crash?
[Reprinted from Money Week, 16 May, 2007]
A sharp fall in real house prices is likely at some point in
the relatively near future. So said David Miles, Morgan Stanleys
UK chief economist, earlier this week. The former adviser to Gordon
Brown believes that more than half of the increase in house prices in
recent years has been driven by the mistaken belief that prices will
just keep rising at double-digit rates. Once these expectations are
disappointed, the market will be subject to a sharp reversal.
As to when the crash will come, he is more vague, suggesting it
could be two years away, and describing attempts at calling the top
of the market as pretty hopeless. I disagree. Look at
the right data and a clear cyclical property pattern emerges. It
suggests that by this time next year, the housing market could
already have peaked. Let me explain.
UK property is very close to peaking
Last year, I claimed in Boom Bust: House Prices, Banking and
the Depression of 2010 that Britain was entering the final two
years of the property cycle, and I still believe thats the
As both David Miles and Bank of England governor Mervyn King have
pointed out, by almost any measure available, house prices are
hugely overvalued. In fact, a recent report from Dresdner Kleinwort
argues that Britains housing market is more overpriced than at
any time since 1948. The investment bank reports that the ratio of
prices to disposable incomes typically peaks at more than six times.
Such peaks were seen in 1948, 1973, 1988 and 2006.
David Owen at Dresdner Kleinwort says: There was an earlier
when inflation and interest rates were both low and the UK housing
market was as expensive as it is today: the late 1940s. As in other
housing corrections, house prices then fell in real terms by more
than 30%. They also fell in nominal terms.
Commercial property is another key indicator of a looming crash.
Property cycles terminate when the supply of highly priced premises
exceeds the demand. According to Jones Lang LaSalle, the property
adviser, rents in the City of London are now expected to rise to
more than £70 a square foot. The last time rents achieved these
levels was in 1988, just before the property market reached its
Understandably, the UKs financial regulator is becoming
concerned that banks are adopting a rather too cavalier approach to
lending and disaster planning. Clive Briault, managing director of
retail markets at the Financial Services Authority, warned the
British Bankers Association earlier this month that banks
should now be factoring in the possibility of a 40% fall in property
prices, and held out the prospect of a 35% increase in the rate of
home repossessions. He pointed out that this was not a prediction
just a severe but plausible scenario.
And yet despite this rising tide of worry, the housing market has
rarely been busier. In its latest house-prices report, Nationwide
stated that in October annual house-price inflation stood at 8%.
Gazumping has returned to tabloid headlines, as bonus-flush buyers
outbid each other for top-end houses in London. Lenders such as
Abbey National are now advancing home loans at five times peoples
salaries, helping to push prices towards their speculative peak.
Some mortgages now offer income multiples of up to seven times
But the fact is that house prices cant rise forever
at some point, people just cant afford them. The current
frenzy of activity suggests a rapidly overheating market, and in
fact the rise in repossessions has already begun, as overstretched
first-time buyers and low income buy-to-let investors feel the
strain from rising interest rates. But when will the real downturn
UK house prices will peak in 2008
In line with my original prediction, I still expect house prices
to stall early in 2008. There will be no single trigger
event the end will come as people realise their financial
resources have been exhausted.
What makes me so sure that prices will peak in 2008? After all,
even the Bank of England cannot decode the housing market
Mervyn King says he and his colleagues are unable to understand why
house prices relative to conventional earnings are as high as they
are. But in fact, one leading indicator is a very reliable
guide to house prices and the state of the economy: land prices.
By looking at data spanning 300 years, my research suggests that
the business cycle tends to work on the basis of 18-year periods,
determined by the dynamics of the land market. The major event that
preceded the recessions of modern history was the rise in the share
of national income paid to the owners of land. Because land is in
fixed supply and people need it for both living and working
the share of national income going to its owners must increase
relative to wages and profits as demand for land grows in line with
In other words, as land, and therefore property, becomes more
expensive (because an expanding economy needs more of it, while the
supply is fixed), spending on property squeezes both corporate
profits and the money available to pay wages. So property-price
growth starts to outstrip both wage and profit growth.
This can be seen clearly by comparing growth in various asset
classes over the past ten years. House prices have risen 187%,
according to the Halifax, against the rise in the FTSE All-Share
index of just 57%. As for wages, over the past decade they have
barely kept pace with inflation. But land prices have taken off on
an exponential trajectory, rising 371% since 1996.
This is far from the first time this has happened. The main graph
above shows a similar jump in land prices leading up to 1989
and then a collapse in the value of that land after house prices
peaked in early 1990. This resulted in the recession of the early
1990s, which hit its bottom in 1992. Historically, the cycle
involves 14 years of stable or rising property prices followed by
four years of recession and so far, this is precisely what
has happened this time around. After the last crash, house prices
began to stabilise around 1993, which suggests 2007 will be the
final growth year for this cycle, with a crash beginning in 2008,
leading to a recession that reaches its bottom in 2010 18
years after the last slump.
And nothing has changed to suggest we are about to depart from the
trend of history. In fact, the only major difference is one that
spells even worse news for the global economy business cycles
across the world have now synchronised, and so have the property
Just look at what is happening in the US. The recent drop in the
construction of new houses was the biggest fall in nearly 16 years.
Prices are weakening, and consumers are borrowing themselves deeper
into debt. But commercial property remains resilient, so it seems
likely that real estate will help to bolster the economy for at
least another 12 months.
Marry the trends in the UK and USA with similar trends in other
property hot spots, stretching from Ireland and Spain all the way to
Australia, and we begin to glimpse why I expect to see a
property-led global depression by 2010.
Can we break the cycle?
Why do we repeatedly see this cycle of boom and bust? The trouble
is that Government economic models focus too much on wages and
profits, and they deliberately ignore the fact that rising land
prices periodically squeeze wages and profits to the point where the
labour and capital markets have to contract (see the illustration
below). So forecasters end up being shocked when output drops below
the Treasurys rosy growth path.
Thats why experts were shocked when the sharp increase in
land values during the Barber boom of the early 1970s was followed
by the recession of 1973/1974. Similarly, the squeeze of the late
1980s (the Lawson boom) was followed by the bust of 1992. And the
Brown boom will be followed by the decline into 2010.
Its too late to prevent the downturn in the latest cycle.
And the only way to break the ongoing cycle of boom and bust is
through a fundamental reform of the tax system, moving towards
taxation on rents paid to landowners, rather than wages and savings
income. This would encourage people to invest more and work harder,
rather than focusing on ways to avoid paying tax on their income and
savings. It would also mean that as the economy grows, and the value
of land rises, so would the money collected by the Treasury to spend
on public services.
Meanwhile, in terms of what investors should do, its easy to
say glibly that people shouldnt buy property, and it certainly
isnt a good time to be thinking about becoming an amateur
landlord. But if you do intend to buy a home to live in, its
more important now than ever before that you are aware of the
potential risks involved and that you have a cushion in the form of
a deposit and affordable monthly repayments.
The people who suffer the most will be those who overstretch
themselves now, such as naïve first-time buyers taking out
interest-only mortgages with no deposit. I believe prices could fall
by as much as 20% in real terms but its important to
remember that the property market varies from one location and
property segment to the next. The buy-to-let sector
especially in the regional cities such as Leeds and Liverpool
will be severely hit, with prices dropping by as much as 40% from
their current selling prices.