We look into why house prices have consistently beaten inflation over the decades.
Before the Eighties boom, the UK’s ‘housemania’ was nothing like as obsessive as it is today.
When Britain got the housing bug
This was partly because mortgage lending was strictly controlled by a legal cartel of building societies. There was only one type of mortgage: a variable-rate loan, with this rate set by the Building Societies Association (BSA). What’s more, getting a home loan involved saving for, say, two or more years with one society, in order to build a decent deposit.
Then along came Mrs Thatcher, whose financial deregulation in the early Eighties abolished this old-fashioned system. ‘Mrs T’ gave building societies the freedom to devise their own home loans and set their own rates, independent of the BSA. To further enhance market competition, she allowed banks to enter the mortgage market.
Also, Thatcher’s ‘Right to Buy’ initiative encouraged tenants to buy their council homes, further stimulating our passion for home-owning. As a result of this new-found freedom and competition, mortgage lending rocketed, as did house prices.
House prices versus inflation, 1953-2009
Unless you’ve lived in a cave for decades, you’ll know that house prices in post-war Britain have risen steeply.
Way back in 1952, the average British home cost £1,891 to buy, according to the Nationwide BS. At the end of 2009, a similar purchase would set you back £162,116. In other words, a house today costs roughly 85 times as much as it did during the post-war austerity years.
Indeed, as this table shows, house prices have massively outstripped inflation (the tendency for the cost of goods and services to rise over time):
|
Year |
General inflation |
House-price inflation |
Difference |
|
1953 |
3.1% |
-1.0% |
-4.1% |
|
1954 |
1.8% |
-1.0% |
-2.8% |
|
1955 |
4.5% |
4.5% |
0.0% |
|
1956 |
4.9% |
3.4% |
-1.5% |
|
1957 |
3.7% |
1.3% |
-2.4% |
|
1958 |
3.0% |
1.9% |
-1.1% |
|
1959 |
0.6% |
4.9% |
4.3% |
|
1960 |
1.0% |
7.3% |
6.3% |
|
1961 |
3.4% |
9.2% |
5.8% |
|
1962 |
4.3% |
5.1% |
0.8% |
|
1963 |
2.0% |
10.1% |
8.1% |
|
1964 |
3.3% |
8.2% |
4.9% |
|
1965 |
4.8% |
7.3% |
2.5% |
|
1966 |
3.9% |
4.9% |
1.0% |
|
1967 |
2.5% |
7.0% |
4.5% |
|
1968 |
4.7% |
6.6% |
1.9% |
|
1969 |
5.4% |
5.5% |
0.1% |
|
1970 |
6.4% |
6.3% |
-0.1% |
|
1971 |
9.4% |
20.8% |
11.4% |
|
1972 |
7.1% |
42.4% |
35.3% |
|
1973 |
9.2% |
23.9% |
14.7% |
|
1974 |
16.0% |
4.5% |
-11.5% |
|
1975 |
24.2% |
10.6% |
-13.6% |
|
1976 |
16.5% |
8.2% |
-8.3% |
|
1977 |
15.8% |
7.7% |
-8.1% |
|
1978 |
8.3% |
27.9% |
19.6% |
|
1979 |
13.4% |
30.6% |
17.2% |
|
1980 |
18.0% |
7.0% |
-11.0% |
|
1981 |
11.9% |
1.3% |
-10.6% |
|
1982 |
8.6% |
7.5% |
-1.1% |
|
1983 |
4.6% |
11.9% |
7.3% |
|
1984 |
5.0% |
13.7% |
8.7% |
|
1985 |
6.1% |
8.9% |
2.8% |
|
1986 |
3.4% |
11.7% |
8.3% |
|
1987 |
4.2% |
12.0% |
7.8% |
|
1988 |
4.9% |
29.1% |
24.2% |
|
1989 |
7.8% |
7.4% |
-0.4% |
|
1990 |
9.5% |
-10.7% |
-20.2% |
|
1991 |
5.9% |
-2.3% |
-8.2% |
|
1992 |
3.7% |
-6.5% |
-10.2% |
|
1993 |
1.6% |
1.8% |
0.2% |
|
1994 |
2.4% |
2.1% |
-0.3% |
|
1995 |
3.5% |
-2.3% |
-5.8% |
|
1996 |
2.4% |
8.3% |
5.9% |
|
1997 |
3.1% |
12.1% |
9.0% |
|
1998 |
3.4% |
7.3% |
3.9% |
|
1999 |
1.5% |
12.6% |
11.1% |
|
2000 |
3.0% |
9.4% |
6.4% |
|
2001 |
1.8% |
13.4% |
11.6% |
|
2002 |
1.7% |
25.3% |
23.6% |
|
2003 |
2.9% |
15.5% |
12.6% |
|
2004 |
3.0% |
13.9% |
10.9% |
|
2005 |
2.8% |
3.2% |
0.4% |
|
2006 |
3.2% |
9.3% |
6.1% |
|
2007 |
4.3% |
6.9% |
2.6% |
|
2008 |
4.0% |
-14.7% |
-18.7% |
|
2009 |
-0.5% |
3.4% |
3.9% |
Sources: Retail Prices Index (RPI) measure of inflation; Nationwide BS House Price Index
As you can see, house prices tend to rise at a steeper rate than general inflation (as measured by the RPI). Indeed, in 36 of the 57 years listed above, house-price rises exceeded general inflation. In the remaining 21 years, inflation rose faster than house prices 20 times, and both were 4.5% in 1955.
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So, I’ve shown that, here in the UK, house prices usually go up at a faster rate than general inflation. However, this is often not the case in other countries, with Germany being a prime example.
Nevertheless, what’s amazing about house prices in the UK is just how steeply they’ve risen against inflation. Had house prices increased at the same rate as inflation, then our modest home costing £1,891 in 1952 could be bought for a mere £40,593 today. Instead, it costs four times as much -- £162,116, according to Nationwide BS.
What’s pushing up house prices?
As I’ve shown, the ‘real’ rate of house-price inflation is usually positive. In other words, house prices tend to rise, even after taking inflation into account. Between 1953 and 2009, house prices rose four times as fast as general inflation.
One interesting question is why have house prices beaten inflation -- by a factor of four -- over the decades? What’s causing this remarkable outperformance? In my view, a complex interaction between several produces this effect:
- Supply and demand: The simplest answer is that increased demand for (or reduced supply of) an item tends to push up its price. Housing demand was very strong during the Nineties/Noughties boom, hence the 12 years of rises. Demand collapsed after the credit crunch, leading to an 18-month crash. Reduced supply since the spring of 2009 has pushed up prices -- although this upward leg is now faltering.
- Cheap credit: One of the biggest factors behind any asset-price boom is a plentiful supply of cheap credit. Mortgage deregulation in the early Eighties created the boom that followed. Likewise, low interest rates created a world awash with cheap credit, fuelling the Noughties boom.
- Lax lending: Each wave of financial engineering tends to lead to more risk-taking by lenders. For instance, bundling up mortgages and slicing them into tranches for investors to buy (known as securitisation) was the ‘secret sauce’ of Noughties lending. Securitisation gave us 100%+ loans, subprime lending, self-certified ‘liar’ loans and so on. Also, it almost caused the collapse of the entire financial system. Oops.
- Investors and speculators: It used to be the case that you bought a home for nesting and not investing. However, after the Nineties crash, buy-to-let investing started to take off, as landlords were lured in by high rental yields and capital gains. Today, there are 1.26 million buy-to-let mortgages, totalling £149 billion -- more than a tenth of the entire mortgage market.
- Rising wages: Steep rises in wages have enabled home-buyers to pay higher and higher prices. In 2008, the average full-time male wage was around £33,000 a year, close to four times the £8,564 paid in 1983. When wages rise faster than inflation, workers are able to pay more and more for housing.
- Falling unemployment: The number of people in work has risen steadily in the post-war period. Today, more than seven in 10 adults of working age (70.7%) are in work, a total of 29.16 million people. As job security increases, so too does our willingness to pay more for property.
- Home improvements: Homeowners tend to add value to their properties via home improvements, such as extensions, loft conversions, conservatories, etc. These investments make homes more attractive and desirable, enabling them to sell for higher prices.
Now for the bad news!
As Herbert Stein, economic adviser to Ronald Reagan, once famously remarked, “If something cannot go on forever, it will stop.” Of course, were house prices to continue to rise ahead of inflation, then more and more of our income and capital would be gobbled up by housing.
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Therefore, what we’re looking at is an obviously unsustainable trend. There’s simply no way that house prices can continue to increase at the rates seen in recent decades. The best of this trend is behind us, as house prices will not go on rising at historic rates.
What’s more, things don’t look good for the immediate short-term future of house prices. Rising supply, falling demand, future base-rate rises, tighter lending, rising taxes, weak wage rises, a sluggish economy and stubbornly high unemployment will act as brakes on the housing market.
In this post-bubble era, I expect the crash to resume in 2010/11.
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