WORDON THESTREET

This pa­per’s new af­ford­abil­ity in­dex will help pre­dict house prices

The Daily Telegraph - Property - - Cover Story - Ed­mund Con­way

Did you miss it? In the Busi­ness sec­tion of this news­pa­per on Mon­day, we pub­lished the first ever edi­tion of our new hous­ing af­ford­abil­ity in­dex. This ex­cit­ing new statis­tic (well, slightly ex­cit­ing) showed that, de­spite sus­pi­cions to the con­trary, house prices re­main af­ford­able — sug­gest­ing that we may not nec­es­sar­ily see the crash so many peo­ple are spec­u­lat­ing about.

Fur­ther­more, our friends at Lom­bard Street Re­search, the eco­nomic con­sul­tancy that did all the com­pli­cated sums, worked out that mort­gage in­ter­est rates would have to rise to above 8 per cent for a full-scale crash to take place.

Work­ing out how af­ford­able houses are is an im­por­tant step on the road to­ward pre­dict­ing fu­ture house price move­ments. This is be­cause — un­like most other in­vest­ments, which one can take or leave at will (shares are a good ex­am­ple) — we all have to live in a house, so there will al­ways be de­mand. The only ques­tion is how much we are will­ing to pay for it.

In the Daily Tele­graph Hous­ing Af­ford­abil­ity In­dex — which you can find at www.tele­graph.co.uk/ eco­nomics — a higher score means houses are more af­ford­able. Af­ford­abil­ity fell by 1 per cent in the sec­ond quar­ter of 2006, as prop­erty prices out­paced wage in­fla­tion, but none the less it re­mains higher now than it was 12 months ago, when house price in­fla­tion was still de­cel­er­at­ing fol­low­ing the re­cent boom.

I must say I was slightly sur­prised by the re­sults. Mervyn King, the gov­er­nor of the Bank of Eng­land, said ear­lier this year that “rel­a­tive to av­er­age earn­ings, or in­comes, or any­thing else you could look at, house prices do seem re­mark­ably high.’’ And as I have ex­plained in pre­vi­ous col­umns, prices cer­tainly have reached a level where many first-time buy­ers are find­ing it dif­fi­cult to get into the mar­ket.

But our in­dex takes into ac­count a very wide range of fac­tors, in­clud­ing in­ter­est rates, house prices, in­come lev­els and the fact that there are more two-earner house­holds to­day than in pre­vi­ous decades. Hav­ing ag­gre­gated all th­ese el­e­ments, it finds that af­ford­abil­ity just about re­mains rea­son­able, even though it has dropped sig­nif­i­cantly since 2001. It is cer­tainly nowhere near the lev­els reached be­fore the last hous­ing crash in the early 1990s.

There are rea­sons to think that prices in­fla­tion will con­tinue. Fac­tors such as large-scale im­mi­gra­tion and a no­to­ri­ously pro­hib­i­tive plan­ning sys­tem have meant that de­mand has out­stripped sup­ply, and this is un­likely to change in the near fu­ture. Lom­bard Street Re­search thinks that be­cause prices are still af­ford­able, we could see house price in­fla­tion hit 10.6 per cent at the end of this year, and re­main in dou­ble fig­ures next year.

I must con­fess I am slightly more scep­ti­cal about this. Sen­ti­ment in the mar­ket has changed sig­nif­i­cantly in the past few weeks, largely be­cause of the grow­ing fear that the US hous­ing mar­ket is head­ing for a crash. As dis­cussed in a pre­vi­ous col­umn, there are rea­sons to be­lieve that this would not nec­es­sar­ily cause a crash over here, but I think it would cer­tainly dampen the mar­ket.

My chief con­cern re­mains the buy-to-let in­vestor. The ma­jor­ity of buy-to-let­ters (by num­ber) are small-scale in­vestors with only one or two ex­tra prop­er­ties. While many of them are in the mar­ket for the long run — say, 10 years or more — I sus­pect that there are oth­ers who will be sur­prised that their in­vest­ment does not make them as much money as they had ex­pected (if it makes them any) in the first few years. If th­ese peo­ple were to sell off in a panic, it could send prices down­wards.

But, re­as­sur­ingly, our af­ford­abil­ity in­dex sug­gests that even if an event like this did oc­cur and prices did drop, the falls would not be dra­matic, since hous­ing is not as over­val­ued as many sus­pect.

We will pub­lish the in­dex ev­ery three months in the Busi­ness sec­tion, and I’ll re­mind you when it’s com­ing up so you don’t miss it.

ed­mund.con­[email protected]­graph.co.uk; Ed­mund Con­way is Eco­nomics Ed­i­tor of The Daily Tele­graph

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