The Terrible Truth About House Prices!

How much longer can house prices keep rising? This report suggests that the end is almost near.

Frankly, I'm stunned that UK house prices have continued to rise for as long as they have.

Indeed, according to data from the Halifax, the average house price has risen every single year since 1996, notching up a ten-year winning streak, as the following table confirms:

*Year*	Average house price (£)	Annual rise (%)
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	170,238	5.3

Source: Halifax

So, over a ten-year period, the average UK house price increased from £61,544 (December 1995) to £170,238 (December 2005). That's an increase of 177%, or 10.7% a year compounded, which is considerably higher than the long-term average for UK house-price growth of about 8%-8.5% a year.

However, wages have climbed considerably in recent years, which should help to support rising house prices, right? Alas, the bad news is that wages have been increasing at a much slower rate than house prices, as the following figures reveal:

Mean average gross annual earnings*

*Year*	Annual earnings (£)	Annual increase (%)
1997	19,375	N/A
1998	20,410	5.3
1999	21,204	3.9
2000	22,104	4.2
2001	23,385	5.8
2002	24,551	5.0
2003	25,330	3.2
2004	25,927	2.4
2005	26,884	3.7

Source: Annual Survey of Hours and Earnings, 1997-2005

(* This is the mean average annual income for all workers, including overtime and before deductions. Note that, in 2005, half of all workers earned less than £18,180 a year before deductions! You can learn more about averages here.)

As you can see, over the past eight years, 'average' pre-tax annual earnings have increased from £19,375 to £26,884, a rise of 39%, or 4.2% a year compounded.

So, house prices have risen far faster than incomes since 1997, which has taken the ratio of the average house price to average earnings to absurd heights, as my third and final table demonstrates:

Year	House price to earnings ratio
1997	3.6
1998	3.6
1999	3.8
2000	3.9
2001	4.1
2002	4.9
2003	5.6
2004	6.2
2005	6.3

In summary, only someone who uses their skull to store rocks could believe that house prices can keep on rising faster than wages indefinitely. Eventually, the housing bandwagon will grind to a halt and will go into reverse.

The main prop which supports today's record house prices is the low cost of borrowing, which this Bank of England report (PDF file; needs Adobe Acrobat Reader) shows is remarkably low by historical standards. When the BoE's base rate starts to rise and mortgage rates follow, as surely they must, the housing market will choke. It's really as simple as that.

Therefore, don't expect extraordinary returns from property for the foreseeable future, and don't overstretch yourself by taking on too much debt!

More: Use lovemoney to compare mortgages, compare savings account and compare credit cards!

Disclosure: Cliff owns shares in HBOS, parent company of the Halifax. He sold his property in 2005 and now rents a home.