We all know that house prices in London and the more affluent areas of the South East have provided one of the hottest spots in the UK economy since the financial crash in 2008, but before deciding whether we should be jumping on this bandwagon let’s first analyse why.
One of the reasons for the crash related to over-borrowing to buy homes which in turn contributed to the problems which beset the banks who had lent the money. In order to prevent the UK economy from spiralling downwards and threatening the value of the homes that secured the banks loans, the Bank of England slashed interest rates and made it more affordable for borrowers to pay the interest on their mortgages. This in turn supported house prices, because with low interest rates homes became more affordable. Lower interest rates also depressed the value of the Pound relative to currencies such as the Euro, and so to European investors UK assets had become cheaper and this led to a massive pick up in overseas demand for London properties which rippled out into the Home Counties.
Good news? Surely lower borrowing costs and rising house prices make homeowners feel much better about life, and perhaps able to spend more in the high street and give a further boost to the economy? Well yes, in the short term there’s no question that low interest rates and a lower currency has helped the UK to perform better than most developed economies, but what now? The recent stock market wobbles have shown that all is not entirely well with the global economy with which the UK has to trade, but that’s for a future discussion. So what about house prices from here?
Let’s start with the good news. It doesn’t look as though interest rates are on the way up until next year – probably after the election in May. No shocks there then, and unlike past interest rate cycles I don’t think many would expect interest rates to return to the dizzy heights of the late 1980’s. Any more good news? Not much – except of course not enough homes are being built and demand for homes in the affluent South East remains high, so there’s no reason to expect a crash any time soon.
Sorry to end on a downbeat note but let’s now look at the flipside. Interest rates will eventually rise again to more normal levels, and even if I’m right and they don’t rise above three or four percent, compared with some of the current mortgage deals available, even that level could prove painful for variable rate mortgages, and when fixed rate deals mature borrowers could be in for a shock. But even this totally misses the point – we’ve become so obsessed with climbing onto this mythical ‘housing ladder’, we’re in danger of losing touch with reality. Let’s remind ourselves why people were able to buy their houses in the 1970’s and 1980’s and repay their mortgages. One word – inflation.
In very simple terms, if inflation was running at say, an average of 10% each year and we borrowed £1 and repaid that £1 ten years later we, in effect, only repaid 35p in current values. And if we used that £1 to buy a home whose price kept pace with inflation, after that decade the value of our home would dwarf our mortgage. So there we have it – inflation is the borrower’s friend.
So what’s changed?
i) Homes are now much less affordable – we need to borrow a much higher multiple of our salaries to afford to buy a home
ii) Inflation is now much much lower, so house prices (and our salaries) are likely to rise more slowly and borrowers could therefore remain heavily indebted for decades
iii) Property taxes have risen and will probably rise further – stamp duty, maybe a mansion tax, council tax….
iv) The world’s financial system isn’t out of the woods and there is now greater economic uncertainty and less job security than in past economic recoveries.
v) The UK labour force will need to be more mobile, with technological advances most workers will need to adapt and retrain more than once during their careers, and change jobs and probably move locations. With high stamp duty and low inflation, moving homes could become an expensive activity.
Conclusion? We all want to own a home but unlike the post war ‘Baby Boomer’ generation, the young adults of today might be advised to wait until they are confident of remaining in the same place for some considerable time, they will also need to ensure that they can afford the mortgage payments even when interest rates rise and, most important of all, they must treat their homes as somewhere to live and not a wealth creation vehicle and a substitute for saving.
