ANALYSIS
Counting the cost
Sheila Manchester reviews a report by Coutts which says that we need a new method of calculating whether house prices are too high – and they have developed it.
H
ouse prices are going nowhere. With the exception of the London market, lenders aren’t lending and buyers aren’t buying
to any comforting level. Why? Interest rates are low, house prices are low, many people still have good jobs, lenders have been told to lend by the Government, so why isn’t the housing market recovering? A major factor is a lack of confidence in
the next 5-10 years, in the fortunes of the UK and the wider world. And a very real feeling that although house prices may be low, the cost of everything else is rising, so affordability is a worry. A recent report by Coutts says that the
two conventional methods of working out whether house prices are too high – the ratio of (a) prices to income and (b) mortgage payments to average income – are sending conflicting messages. Obviously they can’t both be right. The problem with looking at mortgage costs as a measure of affordability is that it does not take into account the full economic cost of owning a home. Now, Coutts & Co has developed a new
method of calculating affordability that shows the full economic cost of owning a home. Coutts predicts that house prices are likely to come under further downward pressure as interest rates are increased over the coming year at the same time as real incomes are still contracting. UK house prices are at historically high
levels relative to incomes, while interest rates are at a record low, keeping mortgage payments below average. The full economic cost, according to Coutts analysis, is somewhere in between, being close to its long-term average. But this is not comforting, they say, as that average is well above the levels that prevailed following the bursting of the late-80s housing bubble.
36 AUGUST 2011 PROPERTYdrum
4.5 4.0 3.5 3.0 2.5 2.0 1.5
PRICES ARE HIGH RELATIVE TO INCOME UK house price to income ratio
Income multiple Average
Source: Council of
Mortgage Lenders, Coutts (Data for 1978 is not available)
1974 1978 1982 1986 1990 1994 1998 2002 2006 2010
INCOME RATIO AND DEPOSITS The average house price is currently close to four times median incomes, at the top end of the historical range and well above the average multiple of 2.8 times. The previous 30 years had seen the house prices/income average around 2.5 times and never hit 3.5 times. Post-2003, the average ratio is closer to four times and has not fallen below 3.5 times (see chart). The main factor is the advent of low
interest rates, which hit 3.5 per cent in 2003, at the time, the lowest level for decades. Easy availability of credit fuelled the subsequent rise in prices and the Bank of England reacted to the subsequent house bust, coincident with the global financial crisis, by cutting interest rates to their lowest level ever. The sharp rise in house prices did not raise mortgage costs significantly above average levels. These costs have now fallen back to very
low levels, so by this methodology UK house prices currently look inexpensive. But to obtain a mortgage the borrower must put down a deposit. Currently, for first time buyers, the average deposit is over £26,000, some four-fifths of the average gross salary. As a consequence of the time required to save for a deposit, the
average age of an unaided first-time buyer is currently 37 years. First-time buyers accounted for only 37 per cent of the market in the first quarter of 2011, the long-term average is 45 per cent. According to Carl Astorri, Head of
Economics & Asset Strategy at Coutts & Co, “To take the cost of the deposit into account, Coutts has augmented the calculations of interest cost by assuming that the money has been borrowed as an unsecured loan. This can be justified on a practical level, as buyers lacking capital seek alterative sources of unsecured borrowings to provide the deposit for a mortgage. On a more theoretical level, it can be seen as placing a more appropriate price on the capital used for a deposit. That deposit is not cost-free, as is only too obvious to those that lack such means, and involves an ‘opportunity cost’ if it is invested this way rather than in other assets.” Coutts’ estimate of the
Carl Astorri
full cost of asset ownership for a first-time buyer shows that costs have fallen back from very high levels, as both house prices and interest
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