The house prices in the UK have yet to crash

According to this report, UK house prices are 20% to 28% too high. But will they fall?

UK house prices have remained 'surprisingly resilient' in recent months, according to the latest survey from Nationwide BS.

Despite worries about mounting problems in the euro zone and the rising threat of a double-dip recession, the UK's largest building society reported that the average value of a home rose by 0.4% this month to almost £165,800.

What's more, with property prices levelling off and even rising recently (notably in London), the average price has climbed by 1.6% over the past year, according to Nationwide.

After the rise, the slide

Then again, these are Nationwide's figures, based solely on its own mortgage lending. Looking at completed sales in England and Wales, prices are down 3.2% in the past 12 months, according to the Land Registry.

The official register of housing transactions claims the average house price is now £160,000. This value peaked at £182,800 in November 2007. Thus, on average, house prices have dropped by an eighth (12.5%) over the past four years. As a result, the Land Registry reckons that house prices today are the same as they were in January 2006, nearly six years ago.

Still too high

Despite price declines since the credit crunch arrived in August 2007, some commentators (including me!) believe that UK house prices are still too high and, therefore, could have further to fall.

For example, The Economist produces a regular review of global house prices. In its latest report, the magazine warns that "the bursting of the global housing bubble is only halfway through".

It reveals that house prices have dived more than a third (34%) from their peak in the USA. Likewise, prices in Ireland have plunged almost half (45%) from their bubble high. However, in some countries (Australia, Canada and Sweden) prices have surged to new highs, while post-peak prices are down around 10% in the UK and Italy.

As a result, The Economist warns that "many property markets are still looking uncomfortably overvalued" -- with our market firmly in this category. As proof, the report offers two long-term measures of housing affordability.

The first is the price-to-income ratio, which contrasts prices with wages. On this measure, The Economist estimates that UK house prices remain a fifth (20%) over-valued, when compared with the trend going back to 1975.

Its second measure is the price-to-rent ratio, which benchmarks house prices against rental income. On this basis, prices are almost three-tenths (28%) above their average of the past 36 years.

By combining both measures, The Economist concludes that British property prices are almost a quarter (24%) above fair value. Hence, for prices to get back to fair value, they would have to fall by close to a fifth (19.4%).

Will prices fall?

Of course, just because property prices remain above their fair value, this doesn’t mean that they will fall. In this new era of ultra-low mortgage rates, smaller mortgage repayments enable borrowers to service much larger loans. Then again, interest rates will not remain low for ever.

Furthermore, a 'mortgage famine' means that riskier borrowers and first-time buyers are being priced out of the market. If euro-zone problems give credit markets another heart attack, as they did this summer, then banks will be forced to pay more for wholesale borrowing. As a result, they will up their lending rates, making home loans more expensive.

On the other hand, we don't have to have another crash (such as that seen in 2007/09) to bring property prices back to earth. One alternative would be for prices to stagnate or gently decline over a number of years, in what's optimistically called a GSD (gradual slow down). However, in real terms (after inflation), wages have been declining over the past two years, so this has yet to happen.

In summary, The Economist warns that "it could take a decade or more before price ratios return to their long-run average in some countries".

Lastly, when the Eighties housing bubble finally burst in the autumn of 1989, UK prices didn't return to their previous peak until mid-1998 -- almost nine years later. Hence, if history is any guide, then we shouldn't expect to see UK-wide prices return to their 2007 peak until perhaps 2016!

What do you think?

Tell us your predictions for house prices using the comments box below!

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