Property Prices in the UK Continue falling – And They Need to Fall More

House prices in the UK are still falling, and at ever increasing rates. Prices fell 2.6% in November and are now 16.1% lower than last year. Realistically, this will continue despite the government’s ridiculous attempts to keep prices artificially high. Gordon Brown knows as much about economics as my pet goldfish.

The Bank of England dropping interest rates to 2% is not going to help increase property prices one whit. Guaranteeing two years worth of outstanding interest charges is not going to make the slightest bit of difference other than perhaps delay the inevitable. Forcing banks to lend at silly low rates is not going to fix the problem.

The current burst bubble is a direct result of the entire nation over-borrowing, with nothing to back it up. Savings in the UK are at an almost all-time low, and dropping interest rates to this level to discourage savers is not far short of insane. It is certainly not going to encourage people to borrow again. Everyone is all borrowed-out. Nor is it going to encourage the banks to start lending money hand over fist to every Tom, Dick and Harry that asks for a 120% mortgage. The current bust is directly related to over lending to poor risks, whilst at the same time not having the deposits to cover anywhere near a sensible portion of the loans. It is no good blaming it all on the US sub-prime loans. And Mr. Brown had a big hand in it.

Gordon Brown - Happy when it was booming, unable to cope with the inevitable bust

With recent house prices in most parts of the country at a level where typical buyers need to borrow more than 6 times their yearly pre-tax salary to buy an “average” house, the banks are not going to get back into the lending business until the market will allow for less drastic lending practices than we have been witness to over the last ten years – otherwise we are straight back in the mire, and no amount of “money supply growth,” will fix the problem.

Therefore house prices are going to fall in 2009 and 2010. Average yearly salaries in the UK are £25,000. Average house prices are still a whopping £158,872. (Depending on the source.)

So, why is reducing interest rates not going to make any difference and how far are UK house prices going to fall?

On the one hand, Gordon Brown is urging banks and mortgage lenders to pass on interest rate cuts and start lending more, on the other hand any fool can see the need for these institutions to be more stringent in their lending practices. So what is realistic? Judging from other countries in the world, a minimum deposit of 20% is going to be required in the future. And with more and more people going into negative equity, that means saving. So lets take that average yearly salary and average house price and an average person.

Introducing Mr. Joe Bloggs. Mr. Bloggs is an average man, with average desires, average income and he wants to buy an average house.

Salary

After taxes, Mr. Bloggs’ £25,000 yearly salary equates to £18,670. Or £1,555 a month take home.

House

Mr Bloggs has found himself a nice average home he wants to buy and coincidentally, this house is exactly at the average price -£158,872

Joe (we know him well enough to call him Joe now) requires a 20% deposit – £31,774

Afterwards, at an average mortgage rate of 6%, spread over an average term of 25 years,  Joe needs to find £828 a month to repay this £127,097 mortgage.

What is wrong with this picture?

Well, Joe’s first obstacle is going to be putting the deposit together. He is an above average saver, so lets say he manages to squirrel away a third of his monthly income. He manages this by living in his mother’s loft to avoid paying the average monthly rent of £1,000. Thanks to the low interest rates, it is almost not worth putting in a bank and Joe is certainly not stupid enough to gamble it on the stock market. But, even living frugally in his mother’s loft, and walking to work, it is going to take Joe more than five years to get the deposit together. Once he has managed to scrape the deposit together, he will then be faced with the obvious problem of having to spend 53% of his monthly salary paying the mortgage off.

So where do house prices need to fall to before Joe can afford to buy his average dream home?

Just as the banks encouraged the housing bubble by over-lending and relaxing their borrowing requirements, they will dictate the burst by increasing their requirements, which means prices will fall to a point where Joe is able to afford his dream home. Realistically, that needs to be a point where Joe can afford to find the deposit by living frugally for a reasonable length of time. At the same time – demonstrating his ability to afford a mortgage once he has saved the deposit. A realistic amount needs to be 25% of his monthly income. £388 a month.

The average UK house price need to fall to an average of £75,000.

This allows Joe to build up his nest egg of £15,000 in a far more reasonable space of time. His mother is already sick and tired of a lodger in the loft, but Joe can now put the deposit together in around two and a half years.

Joe can now comfortably afford to buy his dream home, paying £391 a month in mortgage payments and a small rise in the rate of interest is not going to kill him. Although Joe wisely opted for the fixed interest rate throughout the term and paid an extra 0.5% for the privilege.

Given a reasonable inflation level of 5%, I estimate the housing market will continue falling and level out in the next 2 years at £82,000. This is an arbitrary time frame, that partially depends on how much the government will interfere in the process, and the only thing I can say for sure is that until Joe can afford his house, we are not going anywhere. Dropping interest rates is not going to stop this. Preventing banks from repossessing houses is not going to stop this. It is going to happen. The time to start buying property as long term investments in the UK will be end-2010 or when the average property valuation in the UK  reaches £82,000 (or 5% above this for each year after 2010). Not before.

But don’t just take my word for it. Several others are coming to similar conclusions (albeit using slightly less advanced mathematics than this model.)

The Market Oracle – UK House Prices plunge over the Cliff
The Thrifty Scot – Economists expecting massive house price crash
House Price Crash UK – Raw Facts of Average House Price History

Savings have been falling and have reached a 49-year low. Not since 1959 have household incomes been under this much pressure and something had to give. The housing market was it.

Prices have already fallen drastically in the United States. Measures to keep prices artificially high have failed one after the other. And one could argue that delaying the problem is worse in the long run. The current idea of delaying foreclosures is possibly the worst one I have heard yet. Government interference to this level is the worst answer and Mr Brown needs to take a look at how successful our American cousins have been in propping up their “free market,” before attempting any more mis-guided interference. Before we get to the point where the government owns all the banks and all the houses, which is where he seems to be headed. Let it crash, and let it crash hard. Learn from your mistakes and move on.