Over 90 per cent probability London's in a housing bubble
10 December 2013
There is a 93 per cent probability that London is in the grip of a house price ‘bubble’, which compares to 77 per cent for the UK as a whole, according to research from Warwick Business School.
Professor James Mitchell has undertaken a regional assessment of the housing market in the UK and has found that there is a clear risk that most regions are experiencing house price bubbles. Only Northern Ireland, Scotland and, to a lesser degree, the East of England are less likely to be part of this.
Using house price and earnings data from the Halifax, although conclusions are similar using alternative data, Professor Mitchell has calculated the probability that house prices in each region are higher than historically affordable values.
Unsurprisingly London stands out with a 93 per cent probability but right behind the capital is Wales with an 83 per cent probability and the North West at 80 per cent.
The South West and North East share a 77 per cent probability; while the West Midlands has a 72 per cent probability despite, in the face of the strengthening economic recovery, seeing a cumulative 3.5 per cent drop in its employment rate during 2013.
The South East, meanwhile, has a 65 per cent probability, similar to Yorkshire (67 per cent) and East Midlands (66 per cent).
Professor Mitchell, who is head of Warwick Business School’s Economic Modelling and Forecasting Group, said: “The results raise the risk, although not the certainty, that house prices will fall, although predicting the timing and manner of any fall is even harder than identifying the presence of a bubble. But a bubble it appears to be and we should all - householders, business people and policymakers alike - be alert to this risk.
“Rising house prices are proving helpful in leading the UK out of its longest recession in living memory. But with house prices at such historically unaffordable levels there is a risk that when interest rates start to return to more normal levels, which they will if not next year then the year after, that the finances of both households and banks are stretched to breaking point. This raises the spectre of falling house prices, negative equity, bad assets on banks’ balance sheets and a return to the so-called Great Recession we have been so slowly emerging from.”
While the results of the research show that London is the ‘frothiest’ region in the UK, the presence of house price bubbles across regions suggests national determinants. And Professor Mitchell is not alone in singling out as the key culprits both the 'Funding for Lending' and 'Help to Buy' schemes and low interest rates rather than - which would be preferable but is not happening - rising real wages which would support higher house prices.
“While we welcome the recent scrapping of the Funding for Lending scheme for mortgage lending, the Government and the Bank of England, ideally in tandem, may still want to take additional action now to avoid faster and higher interest rate rises in the future,” said Professor Mitchell. “An unfortunate consequence would be if it becomes tougher to get a mortgage in Northern Ireland, say, because of a London-led housing bubble. There are clear implications for financial stability given the amount of mortgage debt on banks’ balance sheets if house prices drop quickly and households and banks fall into negative equity.
“We all welcome the strengthening UK economic recovery. But not all recoveries are equal. The structure of the current UK recovery raises concerns about its long run sustainability. Ideally we would like an investment and export led recovery – with a pick-up in productivity - but there’s a risk that what we have, similarly to before the global financial crisis, is an emerging consumption-led recovery, on the back of inflating house price bubbles.
“Higher house prices do stimulate consumption by increasing households’ perceived wealth and by relaxing borrowing constraints. So it is possible that rising house prices, by increasing economic confidence, lead to a more balanced recovery with more business investment, but it’s a gamble using borrowed money.”
The Office for Budget Responsibility, in its latest forecast published for the 2013 Autumn Statement, forecast 2.4 per cent growth in 2014 but with household consumption growth driving this and running ahead of household income growth.
Professor Mitchell added: “The Government’s Help to Buy scheme is generally considered to be adding fuel to the surge in house prices. But when credit conditions normalise and interest rates start to rise again, which is inevitable even under ‘forward guidance’, the risks are that consumers stop running down their savings, cut back on what they spend and the UK recovery stalls once again.
“Households are particularly vulnerable to interest rate movements in the UK; even quite modest increases in the interest rate would put significant numbers of householders into quite serious debt problems.”
Professor James Mitchell teaches Managing in a New World on the Warwick MBA by full-time study and Economics of the Business Environment on the Warwick Global Energy MBA.