Ask the expert: Which way for house prices?

The FT House Price Index for September was published on Friday 7 October, providing the most accurate guide to the real trends in residential property prices using Land Registry data. Chris Giles, the FT’s economics editor, answers your questions on the housing market.

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Will we see a slow decrease in house prices from 2005-2007?
Paul Shanahan, Gravure Graphics Ltd

Chris Giles: Anyone who says they are sure what will happen to house prices is either deluded or lying. The best that we can do is gauge the current level of the housing market against many historical comparisons to get an idea what will happen after 2007.

Broadly speaking, over the past 50 years, though the UK housing market has been very volatile, prices have tended to rise a little faster than the size of the economy on average. Since the size of the economy determines households’ purchasing power, this is a reasonable guess for what is likely to happen in the long-term.

In recent years, the nominal size of the economy has been growing at about 5 per cent a year - split between 2.5 per cent real economic growth and 2.5 per cent inflation - so house price growth little over 5 per cent would be a good long-term bet. It is a little over 5 per cent because restrictions and a growing number of households is likely to increase demand for housing a bit faster than supply.

The problem is that at the moment the level of house prices is very high compared with the long term average I have been talking about. This could have two explanations: either it is a bubble, or there are particular circumstances linked to a one-off fall in real interest rates that make the current house prices sustainable.

This is the big debate among housing analysts. If the first explanation is true, prices will not rise at anything like this rate over the next few years and might fall; if the second explanation is true, people could expect the housing market to grow steadily from here.

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I’m thinking of buying a flat as a long term investment. Is now a good time to buy or should I wait for a bit longer to see if prices come down?
Helen Percival

Chris Giles: See my last answer for the long-term outlook. But your question is really difficult to answer because it strikes at the heart of what is not known about the market.

If prices are likely to stagnate, there are certainly better risk-adjusted investments you could make than housing. But if you’ve just missed out on a one-off rise in the market, but which is stable, then housing is not a bad long-term asset: like equities and index linked bonds, it is a real asset that provides a return and (in the long-run) is reasonably inflation proof, but you must remember that the volatility of the housing market is high, so housing is a risky asset too. Buy at the wrong time, and there are lots of eminent economists as well as some more flaky analysts who think this really is the wrong time, and your long-term returns could be extremely poor.

I cannot tell you what to do, but in deciding you should weigh up the costs of waiting (the chance that the housing market will take off again) against the benefits (the returns from an alternative investment you would make with your money). Good luck.

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Everyone in my road seems to have had their loft converted within the past few years. Given such works change the scale of the property and can increase the value of the property, does the FT House Price Index account for this? Calculating prices on a square metre basis would help but I have not seen these data in the UK market.
Sarge Gupta, Twickenham

Chris Giles: The FT house price index looks at all properties of the same type. So you are right that if all properties of that type had big improvements and so could sell at a higher price, the index would show it as house price inflation rather than an improvement in the housing stock.

In aggregate, I suspect the effect is not large - the FT house price index could also understate house prices because it does not take account of depreciation from lack of maintenance - but it could be and, with the data we have, we have no means of knowing whether it is.

My suspicion that it is not important is based on two things. First, while the mix adjusting we do can have a big effect in any one month, over time those effects tend to cancel out. Second, the rate of investment in the housing market is small relative to the stock of wealth tied up in the market itself.

The lenders’ data is slightly better on this score as they have more detailed information to do a mix adjustment.

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To what extent do you think that the recent run up in prices has been down to speculative activity, eg. in the buy-to-let sector. Given the historically low yields on rental property, and the evidence over the last year that recent high growth rates in house prices is not going to continue how do you see speculators/property investors behaving in the coming months? What effect could this have on the wider market?
James Womersley, West Yorkshire

Chris Giles: I think this is an extremely good question. While I don’t know the answer, it clearly has the potential to have a large effect. If investors realise they can no longer rely on capital gains to supplement low yields, some will begin to question whether property is such a good investment. If that number is large, it could ripple through the whole housing market.

It is precisely for this reason that I think it is premature to say the housing market has stabilised at a high level. We will need a few more years before we can be sure of that.

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When house prices are compared to income, is it:

1. the GROSS or NET (after tax) salary of the main earner, or

2. the GROSS or NET (after tax) joint salary of husband and wife or partners.

What is regarded as the normal/safe multiple? And what is regarded as the normal/safe percentage for mortgage repayment as compared to Gross or Net household income?
Bal Lall

Chris Giles: It depends on the analyst. I think the only sensible measure is house price to after tax household income (2 in your definition). This gives a slightly lower multiple of house prices to earnings than definition 1 because the number of two earner families has increased over time, but does not change the fact that house prices to earnings ratios are at all-times highs - and on this measure - property looks grossly overvalued.

There are good reasons, to think that the sustainable multiple has risen in the past decade. Nominal interest rates have fallen, reducing the extent to which initial mortgage payment levels are a constraint on borrowing. Second, real interest rates have fallen, allowing people to borrow a higher multiple of their incomes safely. The question is whether the sustainable multiple has risen as far as the actual multiple. Again, anyone giving a definitive answer on this unknowable fact is rather silly.

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Do you think a new planning tax will reduce house prices or increase them?
Jim Pollock

Chris Giles: If the tax raises significant sums of new money, it would reduce the value of seeking planning permission to build property. At the margin it would probably reduce the supply of new properties, and therefore have an upward effect on house prices. But I think the effect would be small. The big effect of the tax would be to transfer money from developers to the exchequer.

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The latest boom appears to have been driven less by increasing incomes than by increasing affordability, as interest rates dropped. So long as buyers could service the debt, they were prepared to keep paying more. Where do we stand now in terms of affordability? If, as I suspect, we are back to the levels before interest rates dropped, then the market will remain stable for so long and interest rates do, albeit much more vulnerable to relatively small rate increases.
Michael Taite, Worcestershire

Chris Giles: If you include the repayment of a mortgage as well as the interest costs, affordability for a ‘average’ new buyer in the market is no longer particularly new. Lehman’s estimate it is almost 12 per cent above its average since 1987.

The vulnerability to interest rate changes has clearly increased as debt burdens have risen, but the big question is whether people think houses are worth their currently high levels. If not, then it does not matter much what the levels of initial affordability are, prices will fall.

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How do you think the high street downturn will affect consumer confidence in the housing market?
Scott McLean, Practice Head, Hotwire, 33/41 Dallington Street

Chris Giles: Normally the question is put the other way round, and the housing slowdown has clearly had some effect on the retail environment, although it is likely not to have as large an effect as in the past. If the high street downturn reflects an increased desire on the part of households to increase saving and reduce borrowing, then that bodes ill for house prices.

It is not that the high street has a direct link to the housing market, but that a third factor - households willingness to borrow and save - probably affects both.

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Is it a healthy situation that the main providers of data on the UK housing market (apart from the FT) also have significant financial interests in the continued good performance of this market?
Matt Griffith, London

Chris Giles: Not really. But I, for one, do not suspect for one moment that the Halifax or the Nationwide doctor their figures to help their lending portfolios. You sometimes have to take their broader comments about the state of the market with a pinch of salt.

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I find it odd that so many people think that buyers returning to the market in the last couple of months means prices will rise. To what extent would you agree with me that buyers are returning to the market to go bargain hunting? And in the event this is more true than not, would it accelerate the decline in prices? If average sale periods or the number of unsold properties were declining I might take a different view but as it is, it seems obvious what will happen.
Guy B Fancourt, Surrey

Chris Giles: To be kind, the reason people have been linking the number of buyers to prices is that the relationship has been quite good in the past. But I agree with you that the rise in buyers does not imply that prices are just about to start rising again. What I do think it shows is that quite a lot of buyers interested at current prices, so it is an indication of greater stability in the housing market

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Do you believe that the inclusion of residential properties into self-administered pensions after April will generate enough demand for buy-to-lets to cause prices to rise significantly?
Michael Finlay

Chris Giles: No. Very few people understand how SIPPs work and there seems to me to be a lot of misinformation about the products. Worst is when people claim you can buy a £200,000 property with 40% tax relief, so it costs you only £120,000.

What these examples rarely make clear is the following.

1) you can only get tax relief up to your annual salary. So you need to be earning £200,000 a year to get that amount of tax relief. This applies to only about 100,000 people in the UK.

2) Once a property is in a SIPP, it is treated like any other pension asset. So it must ultimately be turned into an annuity and tax must be paid on the income of that annuity.

3) The reasons why rich people hold lots of other assets that can already be put into SIPPs - flexibility, low charges etc - will apply to property.

While there are some rich people who were previously constrained from investing property in a SIPP, who will do so, I suspect the effect will not be large.

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What impact do you consider SIPPS will have on residential house pricing in 2006 and the HIP in 2007 ? Do both of these pieces of legislation create structural changes in demand and supply in the residential property sector which potentially could result in new demand pressures that could drive asset prices?
Chris Harris, Cheshire

Chris Giles: You are right that they ‘could’ drive asset prices. But as in my previous answer, I think the scale of the changes are small enough not to make a material difference to house prices in the short-run. The big question is whether the market is currently over-valued. The answer to this question, which will play out over the next few years, is much more important than relatively small changes to regulations governing housing demand and supply in the pipeline.

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After the death of my mother I have her house to sell. I was advised to put a price of £695,000 on it but, when I pushed the agents on lack of progress they suggested that to seize the autumn market we drop the price by £50,000. In the same road the properties, of which there are about 20, range in price from £500k to £2.5m but I believe there is potential to make the house worth at least £850,000 with some investment.

Do you believe it is worth my while investing £100k and taking the risk that I will cover my investment in the next year? I will have to pay the remainder of the inheritance tax in November but my mother’s funds should cover this.
Kate Farrington, Principal Consultant, Penna plc, London

Chris Giles: The market in the next year is particularly difficult to call. But here are some quick facts.

1) Right now, the prices in the market seem to be pretty stable. Prices stopped rising in the South East last year and have been pretty flat ever since - some months they go up a touch, some months down. Don’t believe any one index - particularly the Halifax index at the moment, which shows almost a 4 per cent rise over the past two months - that suggests there have been any decisive movements in house prices recently.

2) The house price annual inflation rate is falling and there is a good chance it will hit zero in the next few months on some measures.

3) But activity, the numbers of people buying and selling, has been rising back to normal levels.

These facts suggest that the market is showing no signs of imminent implosion and is healthier than it was a year ago. That should be pretty encouraging for you. The one risk is that as the annual rate of inflation falls to zero (as it is likely to do because last year’s rises will fall out of the calculations), sentiment might change and buyers might again become very scarce.

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My endowment won’t pay the mortgage in 2011/12 short by 50-60k. I am working and just about manage to pay my bills. I will be 60 years old in January 2007 and would like to retire due to ill health; I can work up to 2001/12. Do you think I should put my house up for rent in 2007 and sell in 2012 or should I sell now and retire - my present equity is enough to retire and live on in India.
Raj

Chris Giles: I cannot give you any financial advice. You need to weigh up your equity position now and whether this would give you security in retirement, compared with what it would be if you worked on till 2010-2011