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Economists at Capital Economics are disputing claims by the National Association of Estate Agents that house prices will double over the next decade. It may well be in the NAEA's interests to talk up housing but is the forecast realistic?
A doubling of house prices by 2016 would require that prices rise by an average of just under 7.2% a year. Compared to average rates of house price inflation of 9.7% per annum over the past 30 years that figure does not seem remarkable. However, in real terms, if inflation moves in line with the Bank of England's 2% target, the NAEA predictions imply that prices will rise by 5.2% per annum, more than double the 2.3% annual average rate seen over the past 30 years.
One factor behind the rise in house prices over the past decade, namely short housing supply is set to persist. But two other key factors behind the rise in prices since 1996 will not continue says Capital Economics.
First, in the mid-1990s, property prices were clearly undervalued - now most analysts agree the market is overvalued, they merely disagree by how much. Second, the rise in prices was fuelled by the fall in interest rates that accompanied the reduction in inflation. Over a 10 year horizon, higher, not lower, interest rates seem more likely.
Says Capital Economics, "In the absence of these two supports and once we take affordability into account, the potential for house price growth to continue to outstrip average earnings growth seems limited.
"Over the past 30 years, payments in the first year of a new mortgage have absorbed around 38% of take-home pay for a borrower on average earnings. At present, that figure stands at just over 43%. If mortgage rates were to remain at current levels, a doubling of house prices over the next 10 years would push first year payments to 56% of take home pay.
"In addition, with inflation set to remain low, the real burden of mortgage payments will not fall back anything like as quickly as it did in the past. Some further acceleration in house price inflation over coming months cannot be ruled out. But, the combination of an overvalued market, higher interest rates and the fact that affordability is already stretched will prevent house prices rising by anything like 7% a year over the next 10 years."
25 April 2006 © Moneyextra.com
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