Will House Prices Always Rise in the Long Term?
Posted by admin Mon, 19 Nov 2007 10:12:00 GMT
This is, again, a very complex question and one that is often oversimplified by the media. The average article on housing prices in the mainstream press will usually conclude that:
While short term price dips cannot be ruled out, housing is a good investment because prices always go up in the long run.
While is is true to say that, over the past century, house prices in the UK have risen at marginally above the rate of inflation, there is no guarantee that this will continue.
The first point to note is that any rise or fall in prices must always be considered alongside inflation. Many people tell anecdotal stories of how they bought their first house in 1965 for £1000 and now it's worth £5,000,000. But this does not consider the effects of inflation. If housing were to double in value over 10 years, but wages were to double over the same period, then the real value of the house remains unchanged. If it were to be sold, the money would still buy the same amount of food, energy, and everything else, as was the case 10 years before. So when considering changes in price, what really matters is the inflation-adjusted change.
Many people today plan to fund their retirement using the value stored in their home. But when inflation is considered, this plan appears ill conceived. To illustrate this, consider the average house price in relation to the average wage. This has fluctuated over the years, but has tended to stay in the range of around 3 to 4.5 - in other words, the proceeds from the sale of the average house will yield about 3 to 4.5 times the average annual salary. Retirement plans are usually to sell a larger-than-average house, and move to a smaller-than-average house, using the difference to fund living costs in retirement. But if the difference is only of the order of around 3 times the average salary, then it cannot hope to cover living costs for anywhere near long enough.
Hoping for nominal house prices to rise faster than wages for a sustained period of time is potentially risky. Although this has occured for the past few years, at some point there must come a limit where debt servicing costs are simply too great to be manageable. Low interest rates have helped to push the average house price skyward in relation to wages, but it is impossible for this to continue forever. At some point either wages will need to catch up, or prices will need to fall.
There are several reasons why prices may not keep up with inflation over the next 50 years. The first of these is population. Currently the population of the UK is rising, which is putting pressure on the limited housing stock. While there are not currently "too many people", as is borne out by the enormous number of empty homes in the UK, it is likely that if there were "too few people" then prices would need to fall in real terms. A shrinking population would reduce demand for both rented and owner-occupied accomodation causing a readjustment in both rental prices and purchase prices. Falling rental prices would in turn affect purchase prices as a smaller rental income can only cover the interest on a smaller mortgage.
Demographics suggest that the UK population will shrink over the next 30 years. There is currently a demographic "bulge" in the 50-54 age group, and a demographic "slump" in the 15-24 range. The 50-54 age group are mainly owner-occupiers, and the 15-24 group mostly live at home. In the next 20 years, the situation will reverse as these age groups move up the age ranges, and the "excess" of those in owner-occupation will turn into a shortage. A graph (from the ONS) showing the distribution of the UK population between different age groups is shown below.
Notice the bump in the 50-54 age group and the slimmer chart around the 15-24 range. The diagram below shows what the demographics of a country like the UK would look like in a normal situation, to show the difference:
Another factor to consider is rising energy costs. In the last week, unleaded petrol has just broken the £1/litre barrier. Crude oil has come close to reaching $100/barrel. And in recent years we have had concerns over gas supplies from Russia which has pushed the price of household gas higher. In fact, energy costs are now so high that it looks like the UK may return to large scale coal mining in spite of the implications for greenhouse gas emissions.
Higher energy costs are not an accident or a temporary phenomenon. The theory of , which is far too involved to discuss in detail here, states that world oil production will at some point reach an all-time-high and then enter irreversible decline. There is much disagreement as to when this will be (maybe now, maybe in 20 years time), but oil production has been flat for around two years now, whilst world demand has been rising rapidly. If the disparity between supply and demand continues to grow, people are likely to be spending a lot more of their incomes on energy, and therefore will have considerably less left to spend on housing.
The third and final threat to long-term house price appreciation is the government's house building plans. The plans are for 3 million new homes to be built between now and 2020. Currently around 200,000 houses are built each year, so these plans represent a 25% increase to the current rate of house building. This will increase supply, and therefore hold down real-terms prices. More importantly, the government has belatedly recognised that housing affordability is a problem in the UK, and are now at least making the right noises in attempting to bring down the real-terms average cost of housing in the long term.
You may be right on the outcome but your arguments are very weak. No mention of the expected influc of immigrants to take up the demographic slack (the population of the UK is forecast to grow not shrink in the next 30 years!). Hence the governments plan to build more houses. As for oil prices, no mention of the fact that oil rises when the dollar falls. Once the US comes away from the bottom of the economic cycle and the dollar rises again thus will the price of oil return to trend (unless your going to argue that the dollars fall is permanent, highly unlikely, but that would still warrant a mention). Opec have just met and agreed that current production is meeting capacity and will likely exceed it as the global economy is held back by the slowing US economy. I'm no expert but you at least need to give some balance to your articles.
Hi Phil,
Well, that's why there's a comments section after all!
The Government's projection for immigration has been well publicised, but all they appear to have done is taken the figures for the past few years and calculated what would happen if immigration continued at that rate. A similar prediction was made in the 60's and that has turned out to be very far wide of the mark. There are lots of reasons why immigration probably will not continue at the rate the Government expects. Currently, Britain is attractive to immigrants because of our strong economy. But the fall-out from the credit crunch is likely to damage that, making Britan a less attractive choice. Added to that is the fact that the economies of the eastern European countries are strengthening in their own right. So rather than believe the Government's projections, let's stick to what we know about current demographics.
On oil, the movement in the Pound/Dollar exchange rate (or the Dollar Index for that matter) is nowhere near significant enough to explain the changes in the oil price. The Pound has been in the range of $1.90 to $2.10 for the past year, and yet in that time the oil price has moved between $60 and $99!
Anyway, regardless of the current movements of the oil price, it still remains the case that Peak Oil suggests energy will be far more expensive in the future, no matter what OPEC say about the present.