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Playing chicken with house prices

The housing charity Shelter is highlighting [1] 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.

If various foods had gone up at the same rate we’d be paying [2]:

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 [3]. 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 [4], to salaries, or to the price of a Black Forest Gateau in 1971, they are clearly still too expensive: Some first-time buyers [5] 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 [6] 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 [7]:

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.