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Playing chicken with house prices

Playing chicken with house prices

The housing charity Shelter is highlighting the over-valuation in UK house prices by comparing house price rises with the price inflation of milk, bread or a chicken over the past four decades.

Comparing with 1971, Shelter says UK house prices have gone up 40-fold.

  • In 1971, the average UK  house cost £5,632
  • By 2008, the price was £227, 765

If various foods had gone up at the same rate we’d be paying:

  • £47 for a chicken
  • £20 for a jar of coffee
  • £24 pounds for a small portion of mushrooms

Of course, inflation always has an element of ‘sticker shock’. It’s incredible to read that a dozen eggs cost 23p in 1971, whereas they’d now cost around £2.

But that’s still far less than the £9.30 you’d be paying if they’d increased at the same rate as house prices.

Comparing apples with pears?

I believe UK house prices are too high. The average house costs 7-times the average salary – far above the normal ratio, and only made affordable by low mortgage rates.

Nevertheless, while the Shelter chicken in a basket method does make you think twice about accepting crazy prices as normal, it’s also flawed.

Firstly, food has crashed in price over the past few decades, due to everything from supermarkets to globalization. It would be more relevant to see a historical comparison between house prices and rent.

Second, you get more for your money today when you buy a house. Houses in 1971 were poorly insulated, many had dreadful wiring, few had conservatories or loft conversions, kitchens were dreadful, and so on. But eggs are still eggs.

Finally, property is an asset. Anyone who filled their trolley in 1971 and stashed the results in their shed would be nuts to expect it to be worth anything in 40 years. Half of your shopping would rot in a week, and even the tinned food would be suspect in a decade or two.

This is not a trivial point – homebuyers factor in an expectation of having a future asset to sell into what they’ll pay for a house.

Food shoppers simply price in an expectation of how tasty their dinner will be!

House prices will correct – but how?

Whether you compare house prices to rents, to salaries, or to the price of a Black Forest Gateau in 1971, they are clearly still too expensive: Some first-time buyers won’t have paid off their mortgage by retirement!

Yet the house price falls of 2008 didn’t turn into a rout, mainly because of quantitative easing and interest rate cuts that staved off a banking collapse.

Bank rates of 0.5% are not being set with inflation in mind – not even conventional inflation, let asset price inflation.

Analysts at Investec think inflation is going to be twice its target:

Investec predicts a 4.2% inflation rate for January, more than double the 2% target, due to the rise in Vat to 17.5%, higher petrol prices and the impact of the snow on food prices.

For anyone like me who sat out the housing market believing it would correct, low interest rates and high inflation is a terrible combination.

Inflation will whittle down the value of today’s houses more painlessly, with low rates enabling the profligate who over-borrowed to keep their homes, denying the prudent the chance to buy a home at a sensible price before their savings are devalued by inflation.

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{ 20 comments… add one }
  • 1 RetirementInvestingToday February 15, 2010, 9:10 pm

    We are much alike. I too think house prices are over valued. I also am sitting out not prepared to pay the ludicrous prices that are being asked in my neck of the woods.

    My fear now, as I’ve written about, is that governments all around the world are going to take the ‘easy’ route and push the inflation button. This could mean that house prices stay static in absolute terms but decrease in real inflation adjusted.

    If that occurs then I get punished twice:
    – Unfortunately for me working in the private sector I don’t see inflation matching pay rises around the corner. My standard of living then decreases.
    – As a saver I see my assets devalued while those who decided to leverage up get tehir debts inflated away.
    .-= RetirementInvestingToday on: Guest post – alternate investing strategy =-.

  • 2 The Investor February 16, 2010, 10:55 am

    @RIT – Thanks for the lengthy comment, and we do indeed share a fear. Inflation risk while being short one residential property is one of the main reasons I am so stupidly overweight in equities and commercial property at the moment, and why I currently hold no bonds. (Readers – don’t do as I do, do as the experts say! My current asset allocation is very risky).

  • 3 The Investor February 16, 2010, 10:57 am

    Update: CPI inflation has just been announced at 3.5% – way above target. VAT comparisons a big factor, obviously. BBC story here.

  • 4 Lemondy February 16, 2010, 2:37 pm

    “homebuyers factor in an expectation of having a future asset to sell into what they’ll pay for a house.”

    I think that’s a pretty small factor for most people. I think most people buy a house for the advantages of owning their own home (security, etc), not as an investment. It’s a bad habit of people who think about investing all the time to presume that everyone else does the same 😉

    You could well consider that home ownership as an investment is essentially free. The “investment cost” of home ownership should surely be calculated as a delta relative to the cost of renting. Everybody has to live somewhere. Either you own your home, or your landlord does and you must pay (all things otherwise being equal) for the landlord’s yield above the cost of long-term money.

    I’d guess that delta will usually be small or negative, but it’ll vary wildly across location and time?

    So, I totally agree that investing in a house is very risky /as an investment/, and you take the risk of real-terms capital loss on the asset itself. But this comes at a very low cost. People have been bearish on house prices since I bought a decade odd ago. I’ll let you know whether I have any regrets when I’ve paid off my mortgage in 2025 🙂

  • 5 The Investor February 16, 2010, 3:12 pm

    @Lemondy – You write:

    It’s a bad habit of people who think about investing all the time to presume that everyone else does the same

    A very fair cop, guv! It’s taken me a long to appreciate that with respect to houses. However:

    I’ll let you know whether I have any regrets when I’ve paid off my mortgage in 2025

    I appreciate what you’re saying about renters only paying the landlord’s markup above long-term money, but I can’t help thinking that the above slightly contradicts your refutation of my belief that homebuyers appreciate they are buying an asset. That’s exactly what you’ve referenced here, no?

    This aside, it’s an interesting way of looking at it. One mental problem I’ve got is when I first started getting interested in housing as an asset class (rather than feeling like nesting, which is what I should have done!) is that it was at a time when the class was very cheap (mid 1990s). You could easily buy for less than the cost of renting.

    Now it costs more to rent then buy, which as you say makes the difference between buying the house and renting it negative. I don’t see how that can be sustainable (especially with interest rates already at rock bottom lows) unless landlords are much smarter than renters and realize that their housing asset will be worth much more in the future than the current cost implies, which again reinforces that housing is bought as an asset (as opposed to bananas, say).

    Still, my thinking could be muddled. I’ve been bearish on house prices for six years or so and generally wrong, I freely admit. 🙂

    Thanks as ever for your thoughts!

  • 6 Lemondy February 16, 2010, 5:05 pm

    I definitely agree that homebuyers appreciate buying an asset. It’s the “buying to sell” that I’d take issue with. It seems like you lump the humble homebuyer in with the buy-to-let landlords, renovate+flip-ers et al for bidding up prices during the noughties credit bubble in a “sure bet” of turning a profit. I’d argue that in the main, homebuyers are innocent bystanders here, notwithstanding those taking on unnaffordable debts (in the minority, hopefully).

    I don’t want to seem like I’m saying “this time it’s different” concerning house prices. To be clear: I am not at bullish on house prices, and like you have been bearish for a long time. But I just don’t want be blamed for inflating the bubble 😉

    A good article from the excellent Evan Davies on this subject, way back: http://news.bbc.co.uk/1/hi/business/3701070.stm

  • 7 The Investor February 16, 2010, 5:18 pm

    Ah, I see Lemondy. Sloppy writing on my part. I should have said “to own” or “that could be sold” or similar. I may re-write that sentence based on your feedback! 🙂

    Will check out the Evan Davies article asap – thanks.

  • 8 Financial Samurai February 17, 2010, 2:47 am

    I have a thesis. Those who think housing prices are too high are generally renters. Those who think housing prices may be expensive, but expensive for a fair reason are homeowners.

    Given you think housing prices are too high, you are a renter. Correct?

    Inflation ROCKS for homeowners! Inflation by definition means your asset prices are inflating, allowing you to ride the wave. Meanwhile, your debt gets inflated away. Rock on!
    .-= Financial Samurai on: Charles Farrell of “Your Money Ratios” Speaks! Part I =-.

  • 9 Neal February 17, 2010, 8:28 am

    Tough to compare food prices to real estate. They ain’t makin’ any more land ….but they seem to have no problem churning out the tomatoes.

    I have paid off my mortgage and it feels great. Now that I look back on it, I can see that my mortgage payment is like a forced savings account. That’s why people accumulate wealth in real estate over the long-run.

    It’s not the choice of buy vs rent and invest. It’s buy vs rent and spend.
    .-= Neal on: Financial Aid Forms – Best Way To Increase College Aid for Free? =-.

  • 10 The Investor February 17, 2010, 9:45 am

    @Neal – Wow, great feeling. Did you ever consider running the mortgage a little while longer and effectively using it to fund investment? (Assuming you had sufficient tax-free savings accounts available, I think it’s very rarely worth considering otherwise). I think that’s what I’d do, since it’s so difficult to get safe leverage with equities, but I can imagine the feeling of paying off the mortgage completely is joy in itself.

    @Dr Sigmund Freud Samurai – Yes, indeed! 😉 I haven’t always been like this though – and I do change (a bit) with the prevailing conditions. There’s a big post on the site somewhere about how I urged my friends to buy from about 97-2004 but myself kept saving because I wanted a perfect property. It was completely idiotic in retrospect. I’ve thought UK prices were too high since then, which was too soon, and I think they bounced back to soon. This may indeed be because I am renting though; I concede it’s got mildly emotional, which is never good.

    US prices I think from where I’m sitting look fair value now — I’d almost consider investing there if the pound was still back in it’s old $2:£1 glory days!

  • 11 Financial Samurai February 17, 2010, 11:29 am

    I’d invest in San Francisco property if I were you!
    .-= Financial Samurai on: Charles Farrell From “Your Money Ratios” Speaks! Part II =-.

  • 12 Lemondy February 17, 2010, 3:16 pm

    Being a homeowner is an interesting trade-off on the money/freedom/security issue you wrote about recently too. You get the security of owning your own home, but, the insecurity at being at the mercy of interest rates, and/or having to think about future interest rates when (re)mortgaging. (Guess who switched to a fixed rate mortgage in Summer ’08?)

  • 13 The Investor February 17, 2010, 7:49 pm

    On fixed rates, in his lecture I blogged the other day he made the interesting / curious point that Alan Greenspan shouldn’t have been urging people to move to variable rates if he believed in efficient markets as he professed to (and Stiglitz doesn’t) – there should be no opportunity to intelligently profit from your decision. Does that Nobel prize winner’s words get you off the hook? 😉 (Seriously, you’re paying the price of managing risk, right?)

  • 14 Andrew March 4, 2010, 2:26 pm

    I bought my house 10 years ago and at the time lots of people advised me not to, as they said prices were at their peak. Well I’ve now sold it for almost twice what I payed for it.
    The point I’m trying to make is that house prices will always increase in the long term, this is because there’s more people that want houses than there is houses. It’s easy to say that you’re sitting out of the house market untill prices drop, but in the long term they wont. You know what’ll happen to the house prices when the economy starts heating up and those bankers get their £m bonuses back!

  • 15 The Investor March 5, 2010, 2:31 pm

    Ah, well I know you’d expect me to say this but houses were definitely still good value in 2000, based on all the historic ratios (price to earnings, price versus rents, and affordability). I remember people saying that kind of thing too, but it was just because prices had gone up rapidly in a short time.

    I started thinking prices were too high around 2003 – 2004. Don’t worry, I was still wrong! 😉

    I do take your general point and if I had my time again I’d definitely have bitten the bullet, even in 2003, let alone in 2000 (in those days I didn’t buy because of a combination of going freelance and being too choosy).

  • 16 Amy March 5, 2010, 11:05 pm

    I feel your frustration – the last decade has been all about rewarding the financial loose (at all levels, from homeowner to Mega Money Inc.). We’ve been prudent, bought what we could afford and now we rent with no hope of lowering our payments through homeownership.

    US valuations are better on average than UK, but it’s a much bigger market. Where I live in the Northeast, prices are overvalued and rents are stubbornly high despite what I know to be quite a bit of rental vacancy. We actually pay 1/2 of my husband’s net income for rent alone. (No utilities included either).

    I also tend to not see a whole of lot of “innocents” at the ground level. Every single “accidental” landlord I know is so because they saw real estate as endless money. “Smart” people bought houses and let, well, “not so bright” tenants. My sister has been “wanting” to sell for 3 years but won’t take a penny less than peak prices. My landlady has let the second floor of this house go vacant for 4 months now, waiting for someone to pay what she think’s it’s worth. (Only 2 showings, too…)

    Locally our market is very much constrained by people like them, who can’t or simply won’t lower their price. It drives me batty to know that people will let good housing rot or go vacant because they can’t get their predetermined price. It’s an artificial constraint and it occasionally feels like everyone is in on the deal but us.

    Needless to say, we’re ready to pack up and move to an area of the country where housing prices actually match wages. We love the area we’re at, but we can’t justify working this hard to live in decades old track housing.

  • 17 The Investor March 8, 2010, 2:36 pm

    @Amy – Yes, and what we have to fear now is that the US and UK governments could potentially try and reduce indebtedness with stealthy inflation, getting all those over-paying borrowers off the hook. If moving somewhere you like is an option that will enable you to buy, at least having a foot on the housing ladder will help you mitigate this inflation risks. For my part I invest massively in stocks, and cross my fingers!

  • 18 Lemondy March 10, 2010, 12:14 am

    @Andrew says “The point I’m trying to make is that house prices will always increase in the long term”

    Gods man, no. Did the financial crisis EVEN HAPPEN? Hello? Wake up people and smell the coffee.
    I want to start lecturing people about “black swan” risks whenever I see this type of comment. What if there is a flu pandemic in the UK? What if global warming causes the sea level to rise and floods your street? It’s been like two generations since we had a war in Europe and now “property prices can only go up”. Forever? Really?

    @Investor. Very interesting argument indeed about fixed vs variable rates. I think Stiglitz’s argument makes sense only if you can get a fixed rate for the term of the mortgage, so that eliminating interest rate risk is actually an option.

    2-5 year fixes as currently available in the UK are either giving you a false sense of security (“I won’t worry about what happens to my mortgage payments in 2 years time, it’ll be fine”), or are an attempt to “beat the market” by betting on future rate changes. Neither case seems rational to me, though I do it anyway.

  • 19 The Investor March 10, 2010, 1:24 am

    Neither case seems rational to me, though I do it anyway.

    I think to be honest this was partly Stiglitz’s point – he was pretty much saying that Alan Greenspan couldn’t believe in efficient markets AND in second guessing them via saying floating rates are cheaper. Stiglitz definitely believes the market can be irrational…

  • 20 Greg November 3, 2010, 4:52 pm

    When looked at it in those terms the rise of house prices in quite fastastic. Especially in the years 2006-8 when people were making £30-50,000 when they bought a house in UK. To buy property in London was near impossible at the height of the boom. It really is unbelievable that we all thought that that rise was sustainable. If only I had got out early…

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