A housing market bust is likely within the next few years because house price growth has been grounded in unrealistic expectations of double-digit annual rises, a report by a prominent economist and former adviser to Gordon Brown will warn on Wednesday.
Throwing cold water on the current housing market euphoria, David Miles, chief
Once house price rises come down below expectations, he thinks “significant” falls are likely. “A sharp fall in real house prices is likely at some point in the relatively near future, though it could yet be one to two years away,” the report concludes.
Mr Miles’ report comes amid increasing concern that borrowers are overstretching themselves as banks such as Abbey National compete to offer home loans five or more times larger than borrowers’ salaries.
Last week the Financial Services Authority, the City watchdog, warned banks offering large income multiples that they were expected to “stress test” their loan book using statistical models to ensure they could cope in circumstances as extreme as a 40 per cent fall in house prices.
Mr Miles, who was asked by the chancellor to review the mortgage market in 2003, calculates that a little over a half of the rise in house prices has been driven by speculation that prices would continue to rise rapidly. The other half of the rise should endure because it is based on population growth, income growth and reductions in the financing costs of mortgages.
He estimates that at present, home buyers are expecting cash prices to continue rising by as much as 10 per cent a year, compared with 2 per cent in 1996.
These buoyant expectations of price rises, based on home owners’ experiences over the past five years, have fuelled demand and driven prices even higher.
But these forces are the hallmarks of a bubble, which will deflate rapidly once price rises fail to meet expectations. Though Mr Miles’ model shows that under almost any assumptions “a sharp reversal of the recent run up in prices is likely”, he does not predict when it will come.
“The model shows why trying to ‘call’ the housing market over the next year or two is pretty much hopeless,” he says, because small changes in assumptions can have a large effect. But he adds: “Sharp falls in real house prices may not come for a year or so, but come they probably will.”
Earlier this month John Hawksworth of PwC estimated the housing market was about 15 per cent overvalued and there was a one in three chance of house prices being lower in 2010 than today. Mervyn King, governor of the Bank of England, said much the same in May when he said “the level of house prices still seems remarkably high relative to average earnings or average incomes or anything else you could look at”.
Source: Financial Times