No Record High for UK House Prices, says RIT

“UK house prices rose to a new high in August, according to the Office for National Statistics (ONS)” reports the BBC.  “House prices in August were 3.8 per cent higher than the previous year at £247,000 - topping the previous all-time high recorded in January 2008, according to the Office for National Statistics” reports The Telegraph.  “Average house prices in the UK leapt to a record high of almost £250,000 during the summer” reports The Times.  Sometimes I really do despair.  Is there no decent journalism left in this great country of ours?  Before we even get into this posts content let’s be clear.  A new house price high has not been hit.  The last high was back in 2007 and we are nowhere near that today.  Let’s now run the numbers to prove it.

Firstly it’s important to understand that there are a multitude of UK House Price Indices out there with every one of them measuring something different.  I track five of them:

• The Rightmove House Price Index.  It calculates its house price by simply taking the Arithmetic Mean or Average asking price of properties as they come onto the market.  This means it will be affected by price changes, if the mix of house type changes and if the mix of location changes for houses coming onto the market.  It is not seasonally adjusted and covers properties from England and Wales.  So this index really doesn’t track house prices as no purchase is required for it to appear within the index making it pretty much worthless.  I only use it as a possible leading indicator (see below).
• The Acadametrics House Price Index.  This index uses the Land Registry dataset but in a different way.  It calculates its house price by taking the Arithmetic Mean or Average of bought prices.  It then mix adjusts the data to take a constant proportion of property types, from a constant mix of geographic areas.  It is seasonally adjusted and covers properties from England and Wales.  It covers buyers using both cash and mortgages.  
• The Halifax House Price Index.  This index is based on buying prices of houses where loan approvals are agreed by Halifax Bank of Scotland.  It uses hedonic regression to remove type and mix variations thereby measuring the price of a standardised house.  I use the non seasonally adjusted dataset and it covers the complete United Kingdom.  
• The Nationwide House Price Index.  This index is very similar to that of the Halifax except it is based on buying prices of houses where loan approvals are agreed by Nationwide.  
• The Land Registry House Price Index.  This index uses repeat sales regression on houses which have been sold more than once to calculate an increase or decrease.  As it analyses each house and compares the latest buying price to the previous buying price it is by definition mix adjusting its data also.  This is then combined with a Geometric Mean price which was taken in April 2000 to calculate the index.  It is seasonally adjusted and covers properties from England and Wales.  It covers buyers using both cash and mortgages.  

To use these indices we must also remember there is a timing shift between the indices.  Firstly, a house is placed on the market for the first time (the Rightmove Index).  Secondly, somebody possibly buys the house using a mortgage (the Nationwide and Halifax Index).  Finally, the purchase is registered with the Land Registry (the Land Registry and Academetrics).  The best estimate of this timing shift is shown in the chart within the paper by Robert Wood entitled A Comparison of UK Residential House Price Indices.

Let’s apply this timing shift, place all of the indices onto a chart and look at what we have.

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The Nationwide, Halifax and Academetrics, while showing a recent uptick, are all nowhere near record highs.  The Rightmove Index suggests a record high was reached in August and Academetrics shows we have just seen one.  The argument is flawed though because all of these indices are measured in a currency which is being continually devalued through inflation and so is not a constant.  Let’s therefore correct for that and have another look.

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That looks pretty compelling to me.  UK House Prices are nowhere near a new high.


That said I am actually a little surprised that house prices are actually rising in non-inflation adjusted terms at all.  Sure we have plenty of government / Bank of England manipulation schemes in place to try and encourage the punters but when net pay increases are only around 0.5% while we see electricity going up 10.4% along with big increases in food, gas and fuel over the last few years I’m struggling to understand where the disposable income is coming from.  Let’s therefore look at how much of our average punters pay cheque is going on mortgage payments.

UK House Affordability

I believe that the average man on the street knows the price of everything and the value of nothing.  So when he comes to buy a house he doesn’t look or try and assess value but instead is just interested in how much he can borrow from the bank.  This is effectively Affordability.  I try and assess Affordability using a self created UK House Affordability Ratio dataset.  It is defined as the Ratio of Average UK Monthly House Repayments to Average UK Earnings at the point the mortgage is granted.

Let’s first calculate the Average UK Monthly House Repayment.  This is calculated by taking the Nationwide dataset, the Bank of England’s Standard Variable Mortgage Rate (SVR) dataset along with assuming a 20 year, 90% repayment mortgage (the actual value isn’t overly important as it is held as a constant through the dataset for comparison purposes) and is shown in the chart below.

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This shows that between 2010 and early 2013 house repayments flat lined but more recently they have started to rise again having broken out of a repayment range.

We then ratio this with Average UK Earnings to arrive at the UK House Affordability Ratio which is shown below.  Remove the credit boom and affordability continues to be range bound between about 0.40 and 0.45 (represented by the orange lines).  It has however crept a little higher over the past few months and sits at 47% this month.

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So can house prices go higher from here?  If affordability really is the driver then for house prices to rise we are going to need interest rates to fall or household earnings to increase.  Interest rates are now so manipulated that I can’t see how the Bank of England or Government can push them much lower without becoming a direct loss making lender.  I also can’t see earnings rising at inflation or above for some time given we are still one of the highest paid countries in a now globalised world.  So from here at best I can see rates remaining low, which may allow house prices to rise at a rate between zero and less than inflation earnings increases.  I can’t even see it matching earnings increases over the medium term because the real costs to live (food, water, heating) are rising at a rate greater than earnings which when coupled with the fiscal drag we have today will result in less and less free money to spend on shelter.

So can house prices go lower?  Let’s look at house value to answer that one.

UK House Value

The stock market uses the Price to Earnings Ratio (P/E) as a possible valuation metric.  I choose to use the same metric to assess housing value and show this in the chart below.  For Price I use Nominal House Prices and for Earnings I use the UK Nominal Earnings multiplied by 52 to convert to Annual Earnings.   This shows that today we are sitting on a P/E of 6.9.  While still being some way off the credit fuelled peak value 8.3 we are also still far from the 4.6 seen in January 2000.

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Unfortunately, the Average Weekly Earnings dataset limits this analysis to January 2000.  I however want to look at longer term trends to try and judge where fair value may be and even what P/E lows we could expect going forward.  To get an indicator of this I use an older similar dataset which was discontinued by the ONS in September 2010.  This was the Seasonally Adjusted Average Earnings Index (AEI) for the Main Industrial Sectors.  This dataset goes back to 1990 which is sufficient to take us back through the last UK property bust.  I then convert the Average Weekly Earnings dataset to an index and overlay both on the chart below.  This shows that today we are still nowhere near fair value.

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So can house prices go lower?  Absolutely.  All it would take is the market to decide it’s time for interest rates to rise.

In the interests of full disclosure I must highlight that I remain out of the UK property market.  This is simply because I believe the market is overvalued and I try not to buy over valued assets.

As always DYOR.

Definitions:

• Arithmetic Mean.  This is more generally called the Mean or Average.  It is simply the sum of a series of values divided by the number of values.
• Geometric Mean.  This is a little more confusing but can be calculated by taking the log of a series of values, then Averaging these values and then converting back to a base 10 number.  Sounds confusing.   Instead, let’s think about why we might use a Geometric Mean for House Prices.  In simple terms a Geometric Mean tends to dampen the effect of very high or low values which could bias the Average.  In the house price case we have a very long series of high house prices and so this statistic will dampen that affect.