Why House Prices Must Fall

By Cliff D'Arcy | 29 April 2008

In the twelve years from 1996 to 2007, UK homeowners and property investors enjoyed an extraordinary winning streak. As the latest housing boom started to gather pace, here's what's happened to house prices:

House prices rocket...

*Year*	*Average house* *price (£)*	*Yearly* *increase (%)*
1996	66,094	7.4
1997	69,657	5.4
1998	73,286	5.2
1999	81,595	11.3
2000	86,095	5.5
2001	96,337	11.9
2002	121,137	25.7
2003	140,687	16.1
2004	161,742	15.0
2005	170,043	5.1
2006	187,250	10.1
2007	196,792	5.1

Source: Halifax House Price Index

So, over this twelve-year period, the average house price almost tripled. In fact, it rose by 198%, or an average of 9.5% a year compounded.

My next table shows how the average wage in the UK has inched up over the same period:

...while wages creep up

*Year*	*Yearly wage* *increase (%)*
1996	3.6
1997	4.2
1998	5.2
1999	4.8
2000	4.5
2001	4.4
2002	3.6
2003	3.4
2004	4.4
2005	4.0
2006	4.1
2007	3.9

Source: UK Statistics Authority

As you can see, between 1996 and 2007, the average wage increased by between 3.4% and 5.2% a year. Over these twelve years, wages increased by 63%, or 4.2% a year compounded.

What does this all mean?

House prices up 198% versus wages up 63%

As house prices increase at a much faster rate than wages, we are forced to spend more and more on housing costs. Lower interest rates have helped to limit the impact of this trend, but cheap mortgages can't bail us out for ever.

Indeed, if wages and house prices continue to rise at these historical rates, then house prices would treble again by 2029, while wages would climb by less than two-thirds. In this scenario, the average house would cost over £586,000, while the average wage would be under £40,000.

Of course, this absurd situation will not arise, which doesn't bode well for the future direction of house prices.

A lesson from the last crash

No amount of financial flimflam can convince me that house prices can rise at anything like this rate over the next couple of decades. However, some housing pundits and vested interests believe that the housing market will continue to defy financial gravity and go into a ‘gradual slowdown'. Alas, this smacks of desperation to me, so I'm far from convinced!

When prices peaked in mid-1989 and started to fall, it took until the first quarter of 1998 for the average house price to reach its former zenith. That's nearly nine long years of falls -- and it ignores the depreciation caused by general inflation.

Thus, I believe that prices will not stand still while wages struggle to catch up. It's not how asset-price booms end, as revealed in Edward Chancellor's excellent book Devil Take The Hindmost: A History of Financial Speculation.

So, put on your tin hats and hunker down, because, in my view, the 2.5% fall in house prices recorded in March is only the beginning!

For the record, Cliff sold his family home three years ago and is patiently sitting out the property crash as a tenant.

More: Use the Fool to find your ideal mortgage | Five Top Two-Year Mortgage Deals | Six Smart Rules For Renters

Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool.

At 14:53 on April 29 2008, atalayones said:

what should a person with a 95% mortgage do -try and sell up - rent and wait??

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At 15:02 on April 29 2008, jerryrc said:

Agree with all this. Would go further and say that in past cycles prices usually overshot the other way as well. Prepare for major price adjustment in my view.

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At 15:19 on April 29 2008, buyhard said:

"For the record, Cliff sold his family home three years ago and is patiently sitting out the property crash as a tenant."

A former boss of mine did the same - in 1999! In my opinion, being out of the property market is not Foolish. Like all investing, it's very hard to pick the top or bottom of a market...

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At 17:17 on April 29 2008, rober09 said:

I am always amused when those with a vested interest in housing are asked to comment on house prices. I have yet to see such an estate agent,property site or surveyor say other than the market is "fine" or at best somewhat begrugingly "is slowing down but will shortly improve because of the shortage of houses in Britain". Not one of these people ever suggests that overpricing or lack of credit availability is having any serious effect on the market, either now or in the future.

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At 07:23 on April 30 2008, purplepatch said:

All very depressing. What would interest me would be the difference in real affordability, ie percentage take home pay, as it was the 15.4% interest I paid in 1988 that killed me and not the original mortgage amount. So here's some mickey mouse maths. If the average wage now is £24,500 then 12 years ago it was £15,000, that's roughly £940 a month take home. Average house price was £66,000 at 95% mortgage at 15.4% (1988 rate, I know this is wrong but bear with me) = £804 interest only. So the average house price cost the average wage earner 85% of his take home pay. Nowadays, average wage is £24,500 = £1,500 per month take home. So average house = £197,000, average mortgage = £1,013 per month = 71% of average take home. So actually unless interest rates rise sharply mortgages are still more 'affordable'. OK, I know some of this is an oversimplification as I don't know the average wage and average house price in 1988 so I have used 1998 prices but with the 1988 rate - but if the clever people at fool could work it out properly it would be really interesting

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At 08:28 on April 30 2008, Mark0768 said:

I have been banging on about this problem for years, but no one seemed to understand the consequence and relationship between salaries and house prices.

I feel very strongly about residential investment and firmly believe a house should be a place to live. Investors have swooped in like a swarm of locust and have ripped the heart out of the tradition English home. The government should have legislated in bank lending; because lets face it they got greedy, this would have controlled the buy to let market and slowed house price inflation.

We are now in a position where everyone now knows, but even now, when the truth is pushed in peoples faces, I still hear people talking about prices rising when the banks start lending; ….. NO this will not happen!

While we have been patting ourselves on the back for recovering our bank charges, the banks have been busy loading us with increasing debt by dangling a golden carrot and making us believe it will go on forever.

I see a slow fall in house prices, maybe as much as 20% I think it will be a slow fall because there are still enough people out there who think house prices will still rise.

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At 08:51 on April 30 2008, DAQ80 said:

purplepatch, your basic maths does generally suggest the correct conclusion there or thereabouts and I've seen it elsewhere. However the 15.4% interest rate you mentioned was a very brief period of around a year, and the cost of mortgages by the end of 1990 at the peak of the boom they are now.

The likely outcome has to be that prices will fall. Predicting by how much and by what point is a mug's game however. Buying at the moment is fraught with difficulty and anyone considering it should ensure that they drive a very hard bargain. I'd like to think that there would be a gentle decline which won't cause mayhem, but I'm yet to see any asset prices timelines which show a very sharp prolonged rise and then plateau...

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At 08:54 on April 30 2008, SiGl26 said:

"When prices peaked in mid-1989 and started to fall, it took until the first quarter of 1998 for the average house price to reach its former zenith. That's nearly nine long years of falls"

Not by my arithmatic - if by '98 prices were back to '89 levels, they had fallen and climbed again!

Atalayones - think of the interest on your 95% mortgage as renting from your lender; what rent would you have to pay for the same property? How much of YOUR 5% would you lose if you sold now? How much would it increase if invested elsewhere while you rent (don't forget you'd pay some tax on the gain)?

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At 08:56 on April 30 2008, CakeDelux said: