What we are about to do is to look at how you can work out what
is likely to happen to house prices and whether it is a good
time to buy or not. The previous two blogs showed in no
uncertain terms that it is a fallacy that house prices always
rise over time. In fact, for most of history quite the opposite
has been the case. After all, looking after houses is expensive,
what with repairs, insurance, and taxation. Not only that but it
certainly seems to be the case that the government has over the
recent past been making home ownership more and more onerous
with more and more regulation.
For the moment we will put aside government interference (a
subject to be dealt with in a later blog) and look at the
basic charts that we will need to show us how the housing
situation is coping with modern trends. Most people will give
you a list of indices that you should watch in order to gauge
the direction of prices. Those lists will usually be totally
wrong. My list consists of six items. Here they are:
The Affordability Index
The Rent to Mortgage Costs Ratio
The House Price Index
The Indices for Wages and Inflation
The Auction Index
We also need to know the state of the mortgage market
Let's start with The Affordability Index
The latest figure for the UK as a whole is 5.2. But first, let
us be clear about what this means.
I am not sure how precisely the figures are calculated, but
the way I originally designed this index way back when I was
at college was that affordability was simply put at a monthly
mortgage cost of 40% of income after taxes.
It's interesting to note that in Scotland at the height of the
affordability crisis in 1991 the level was just short of 40,
whereas at the same time in the south east it was just over
70. There appear to be different freak-out levels across the
country. In the Midlands it appears to be around 50. In the
southwest the level appears to be just above 50. In London it
is around 60.
The figure for the South-East I find frightening. Quite simply
I donít understand how people survive when they are paying 70%
of their income (or even 60%) on housing. However, what this
does is to give followers of this index a good idea of where
the danger points are across the regions.
There is another way of calculating the optimum amount
payable, and that is to take the mortgage business standard
maximum allowable mortgage compared to actual income. That is
generally three and a half times earnings for a single wage
earner, with an addition of one extra wage for a partner,
giving a maximum total of four and a half times actual income.
If we use this latter calculation we find that the figure of
5.2 shows houses to be slightly higher than the affordability
figures would indicate to be the optimum.
It is not the case that the figures shouldn't or can't rise
above the optimum, after all optimum is not the same as
maximum, but what we can say is that house prices are already
high enough. After all, in 1995 the figure was 2.2. Clearly
that was the time to buy, and the time I was telling my
clients to get stuck in.
The really expensive areas are London, The South-East, and the
South-West. You can find the full up-to-date figures on the
Nationwide web site.
My own rating suggests that overall house prices are at
average levels over most of the country, slightly above in the
South, and overpriced in London.
House prices have been rising slowly, but in line with wages
for most of this century, but over the past quarter they have
risen more dramatically. In parts of the country these rises
are probably sustainable, but less so in the South, and
probably unsustainable in London.
interesting view of housing unaffordability. I take their
point that there is a difference between mortgage
payments/house prices, and income/house prices (mortgage
payments are always related to income, but interest rate
changes will impact on the mortgage monthly payment, and this
is a changeable sum. However, I maintain that a rating of 4
would mean housing costs were affordable. A figure between 4
and 5 would mean house prices were slightly unaffordable. A
figure above 5 would mean houses were unaffordable. The higher
the figure from there, the more the market would be
overbought, seriously overbought, or ready for a crash.
The bottom line here is that although house prices are
generally a fraction above an optimum level, they are not
overly expensive. We have to see if there are alternative
indicators that might foretell a slide in prices.
Price to Rent Ratio
The price-to-rent ratio is a calculation that
compares median home prices and median rents in a particular
market. We simply divide the median house price by the median
annual rent to generate a ratio. At the peak of the U.S.
market in 2006, the ratio for the U.S. was 18.46. The ratio
dropped to 11.34 by the end of 2010. The longer-term average
(from 1989 to 2003) was 9.56. As a general rule of thumb,
consumers should consider buying when the ratio is under 15
and rent when it is above 20.
This ratio is used as a benchmark for estimating whether it's
cheaper to rent or own property. In other words the
price-to-rent ratio is used as an indicator for whether
housing markets are fairly valued, or in a bubble.
Rents vary significantly from area to area. This is a ratio
that you must discover for yourself. Let me do a calculation
based on a small area in West London so you can see how it
A two bed property has recently been sold for £300,000 in the
designated area. The cost of that property in terms of the
monthly mortgage payment is £15,000 p.a. That's the cost of
the money at an average mortgage interest rate of 5%.
In the same area a similar property is for rent at £1,100 a
month. That works out to £13,200 a year. In other words it's
cheaper to rent. Once the figures start to significantly
diverge then we are due for a change simply because people
will either find renting too expensive and decide to buy, or
vice-versa. When the difference between the two figures gets
above 20% one can expect more people to prefer renting if that
One does have to be careful to add and subtract all the
relevant figures. Using the above figures, the real maths come
out like this:
House Sale Price: £300,000; 80% loan to value mortgage,
therefore deposit of £60,000.
Outgoings: Cost of mortgage monthly repayment + Cost of
deposit (loss of income from that sum) + Estimated repairs and
renewals + Local taxes + Insurance.
Rental: £1,100 + Local taxes
It's surprising how the cost of buying a house does rise,
sometimes considerably so, above the bare cost of the
This indicator is very much a localised one. You need to
compare similar types of house in similar areas. Generalised
figures will not be indicative.
I will deal with the rest of the indicators in next week's
blog. See you then. And do please hit the Like button to give
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