Where Next For House Prices?

April 10, 2006

This article continues a series on homebuying and mortgages.

Is housing a good investment? You can't pick up a paper these days without reading about the latest house price survey and wild predictions of either boom or doom. But let's step back and look at the long-term picture to get some perspective. This means we have to look at some numbers, so brace yourselves!

House price history

According to the Nationwide, house prices have increased by an average of around 9% a year since it started monitoring them in 1973. By way of comparison, the average rate of inflation over that time period has been about 7% a year. The Halifax House Price Index starts from 1983. Since then, it shows house prices have increased by around 8% a year as opposed to inflation of 4.5%.

It's important to take such figures with a major pinch of salt if you want to use them to assess what sort of returns you can expect from housing. For example, house price indices only include houses that have been sold in the period concerned, which are likely to be a small fraction of the nation's total housing stock. They also don't include any rental income you could receive or costs such as maintaining the property.

That said, both the main house price indices show the same story and that is that house prices have beaten inflation by a small amount over the long term. So there is a reasonable case for saying that housing is a decent investment, although the actual returns tend to be less than most people think. Over shorter time periods house prices can fall of course, although it is rare for them to do so. Most recently, in the period from 1990 to 1995, house prices fell by around 10%.

Where next for house prices?

Unfortunately it's impossible to say what will happen to house prices in the future with any degree of accuracy. However, one reasonable indicator in the past has been affordability in relation to average salaries. The common yardstick is to say that housing is fairly valued if average house prices are three times average salaries. At the moment this ratio is around six times, indicating that housing is very expensive. This has led some people to predict house prices may be due for a fall.

Interest rates are low at the moment though and this means people can get a bigger mortgage than they could several years ago but for the same monthly payment. So other commentators, who believe housing is not overvalued, argue that the proportion of our earnings spent on mortgages is still comparable with historic levels, being in the region of 30%. However, an important flip side of this argument is that inflation doesn't make the monthly amount you pay increasingly more affordable as the years go by. People who bought their properties in the 1970s and 1980s saw their monthly payments reduce significantly in real terms as they got near the end of their mortgage term.

So what can we conclude from all this? It's best to see your home as a place to live in first and foremost and secondly as a long-term investment. Prices can fall in the short term, although it is relatively rare. So when house prices appear high on some measures, as they do at the moment, you don't want to overstretch yourself. We'll look at this in more detail in a later article in this series.

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