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