What goes up....the real threat to house prices

by Anthony Hilton, Financial Editor of the London Evening Standard

Two independent studies published mid-February produced more fundamental reasons to worry about house prices. However, they are not concerned with a downturn induced by the short-term problems of the economy; their analyses point to a fundamental shift in economic conditions which could mean that the great long-term upwards trend in housing is about to turn the other way.

The first is from Tim Bond of Barclay's Capital in his annual Equity Gilts Study, and, though he took most of his data from the United States, much of what he concluded is applicable to the UK. Having studied long-run trends in house prices he concludes that the only reason people were prepared to pay as much as they did was only because they expected further increases. Home buyers probably don't need an economist to spell this out for them, but it does underline how prices have lost touch with the underlying economic reality.

Bond highlights how people had only been able to enter this world of unreal pricing because of the exceptional conditions in world markets - the deflationary pressure from China, the glut of world savings and the willingness of central banks to cut interests rates at any sign of an economic slowdown. This has allowed the huge rise in personal debt which has driven the surge in house prices. But the party is now over because global economic conditions have changed fundamentally. Global inflation is back and with it volatility. Central banks can no longer indulge the world's borrowers with easy money at low rates. The prop under the housing market has been removed and prices must fall.

The ABN Amro/London Business School produces the other analysis in the annual Global Investment Returns Year book. One section dealt with momentum investing - where investors buy what is going up and sell what is falling. It shows how the public's willingness to buy houses depends on whether prices are rising or not and on the availability of bank finance. If they look good people will take on more debt, and then small changes in the amount people are allowed to borrow, say from 75% to 80% of the property's value, have a massive impact on prices. Indeed, the authors reckon a 7% change in loan-to-value ratios causes a doubling of house prices.

And the corollary is that as banks tighten up and the money is no longer available, as is now happening, the prices go into reverse. And just as they went up far more than you would expect, so too will they fall.

Anthony Hilton is Financial Editor of the London Evening Standard and international columnist and speaker