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Affordability is the problem in the UK housing market...

The problem in the UK housing market is affordability – or the lack of it. We are nowhere near the levels where the market can start to resuscitate. The Nationwide Building Society’s first-time buyer affordability index (black line on the chart below), which measures initial home loan payments as a percentage of take-home pay (so the higher the index, the worse affordability is), is still five years away from a market trough if the last housing downturn is anything to go by.



The low on the affordability index was 46, in March 1996, which was around about bang on when house prices finally began to trend up again after the 1989-95 sell-off. House prices are of course part of the mix of the affordability equation and so it’s no surprise to see that the index fell faster in the early days of 1989-93 than it did when house prices were much closer to levelling out in 1993-96 (i.e. still falling but at a much slower rate).

Bringing that analogy forward to today’s market, the index (which is quarterly and lagged, so the most recent datum is December 2008) is currently 105.7, or less than a third of the way down to cycle-low affordability. As at end-December, the Nationwide house price index was 14.75% below its peak. Can we say that a drop of that size is likewise less than a third of the required correction? Probably not, but almost no matter how you look at the UK housing market – be that through the UK house price to history ratio; the house price to GDP ratio; the ratio of house prices to other assets, or house prices to earnings – you get the same sort of target fall: 40-50% in real terms. Given that 1989-1996 saw a real-terms drop of nigh-on 40%, that’s not so surprising.

...but that's only half the story

Aha! Say some. Surely the late 1980s were characterised by super-high interest rates, so it was no wonder prices fell. Well actually, the super-high rates were at the peak of the market. Rates fell every year from 1990 to 1994 and again 1995-1996. Yet real house prices fell in each and every year. Because affordability (in terms of monthly outgoings) is only half the story. If I’m a buy-to-let landlord and my rental income now exceeds my home loan payments (for the first time in quite a while) that does not mean I make money, even after all costs.



The change in the value of the property is critical. Even small percentage changes in capital value far outweigh any considerations about rent, a fact that the property cheerleaders made the most of during the upswing. Even though we could see it would all end in tears because rents weren’t covering outgoings, landlords were still enjoying total returns that were comfortably positive.

In the end, it wasn’t just net rents that couldn’t cover a 100% home loan – some landlords found that gross rents (before all costs, voids, etc) wouldn’t even cover loans that were well short of 100%. Such warning signs went unnoticed by far too many people. Yet now, many still want to rush back into the burning building just because a temporary change in wind direction has blown the smoke away to one side.

HBOS, presumably a bit concerned by just how unaffordable its data was making UK houses look, stopped publishing its house price to earnings ratio in early 2006. This is just one of the problems with data on housing: it all comes from less-than-neutral sources such as estate agents and lenders. Still we can do a rough update by using HBOS house prices and weekly earnings from the government’s ASHE (Annual Survey of Hours and Earnings).

According to HBOS, house prices peaked out in August 2007 at £201,000. Average weekly gross earnings in the UK in 2007 were £376 (£19,552 a year). Multiplying that by about 1.5 brings single person earned income up to (earned and non-earned, usually two-person) household income of around £29,900. The house price to income ratio would therefore have been around 6.72 times at its peak, using the HBOS measure.

So have house prices hit the bottom?

On the same basis, today, the ratio, based on an assumed average household income of £31,200 and an average HBOS house price of £160,869 is still a very high 5.16 times. To give you an idea of just how high that is, it’s still above the 1989 peak ratio of 5.02 times.



Now if that looks like a fully mature sell-off to you, then I say go for it and pile back into the property market. Personally, I think I’ll wait until either one of the affordability or the long-term house price to earnings ratios returns to ‘buy’ signal territory.

History says it may take a while; perhaps three to five years. But history also suggests it’ll be worth the wait. The downside could easily be 40% in real terms, even from here. Just look at what’s happened in the US already (-32% and falling, judged by the Case-Shiller index) if you don’t believe me.

BUT-IN the USA there has been an over supply of property.This is not the case in the UK.

Is earnings to house price ratios really relevant? In most homes now there are 2 income earners and not one as use to be the case.Perhaps then the average salary should be doubled to get a more realistic ratio.?

Hi Mr Ignorant,

Your post is well informative. Much appreciated indeed.

Regards,

Khondkar

Lies, damn lies and statistics.

There is enough truth in the post to make it interesting. At the same time there is an odd assembly of the facts to promote the conclusion.

Affordability means what? If the measure is monthly payment the peak of affordability was 1996 as that is when lower interest rates and lower house prices combined to make the monthly bill affordable.

If we want to discuss BTL then drawing any conclusions before 1996 is problematic. BTL financing did not get rolled out until the end of 1996. Prior to that there was no real private rental sector. Even with the BTL loans on offer it was not until 1999 or 2000 that the take up was all that high. The key is not really which year marks the start but the observation that the past house price crash had no real investor element while this time around investors are a 10% or more of the market. It might be argued that BTL investors have taken up much of the slack left by the retreat of the FTBs.

When someone says there is a surplus of housing in the US it masks a lot of important details or just shows a naive understanding. There are parts of the US that peaked 40 years ago in terms of population while other parts that are still seeing a positive growth rate. How much housing exists in the US does not factor as people do not look across the whole of the US when they want to buy a house. They look very close to their present home or where they work. Hence it is the local supply and demand that matters. The US had rising house prices (except for one flat year) for a total of 63 years. Even still local markets went up or down over the 63 years. An average covers a lot of sins.

Investors do not buy the average. They do not even buy an average for a small community. If they are buying BMV deals then by definition they are buying below the open market value. If the same investor sells on in the short term or holds for 20 years with positive cash flow over the full period the current average has even less importance. 

I love the statistics that tell people the market is going to fall or they can buy at some later date. in the mean time they are panicked when selling or very willing to pay me rent as a tenant. Either way I am just fine. It is almost impossible for me to buy an average so why should I care. Asymmetric information implies that it is possible to hold better info than the other side. The more people think averages impact them the more I have the upper hand.

John Corey

Follow me on Twitter -> www.twitter.com/john_corey 

Well explained John my sentiments entirely...

Its like the statistician who couldnt swim - who drowned after jumping into a lake that had an average depth of just 3 feet.

what john said, including the big words

i am just dissapointed he did not get hyperbole/hyperbolic in there somewhere, thats a great word

Rik

John,

I think you might be just a little wide of the mark here.

There was "no real private rental sector" prior to 1996?

Sorry, but that is either laughably naive or wilfully deceptive. I graduated in the mid-1990s and can remember there were plenty of options to rent. Undoubtedly BTL took off later and has changed the market a lot, ensuring there are even more plentiful rental options, but you were not serious with that comment were you? It's hard to tell when someone is joking on an Internet forum.

"It might be argued that BTL investors have taken up much of the slack left by the retreat of the FTBs."

Alternatively, it might be argued (for example, by people who are not blinkered by their status as BTL investors) that BTL investors drove the retreat of the FTBs by outbidding them and driving rental yields to very low levels in the process. It is hard to believe now but, yes, "investors" were willing to drive yields to below their cost of borrowing and finance the mortgage themselves safe in the knowledge there was a Greater Fool who would take an even lower yield tomorrow.

The rest of your post really seems like an exercise in soothing yourself rather than a cold, hard analysis of reality. It does not ACTUALLY really address the content of the original post - the central argument was that houses in the UK remain unaffordable, suggesting the bear market remains intact, yet affordability barely gets a mention in your response. I'm surprised other readers found your response so helpful (unless perhaps it soothed them too).

Regards,

No Troll.

The private rental sector in the UK probably goes back to the Second World War or maybe before that. Renting out houses and rooms in university towns has been going on for ages. The image of the Britsh land lady renting out her spare room by the sea was often portrayed in B&W films in the 60's not to mention Rising Damp in the 70's and the Young Ones in the 80's.

Not much to do with the original post I know! 

Check the facts.

PRS in its current definition is property owned as an investment by an individual. Prior to the financing changes that came about after the AST individuals could not obtain financing for a residential investment property. Commercial finance (normally requiring a company as the borrower) did exist. The PRS data shows a tiny or non-existentant base prior to 1996. There are multiple reports on the topic and the government has published some of them. The total number of rental properties was low. The mix was bias towards what today we call HMOs. Flats and homes were much less commonly available than they are now with the PRS.

If you want to come back to affordable housing we need to agree terms. A home that is affordable to live in or a home that is affordable to own?

In addition, UK homes are not unaffordable in an absolute sense. You need to state a context. The peak of affordability in terms of monthly payments was 1996 as interest rates had moved down, wages were good and house prices has not lifted much from the prior crash. Based on the past data that I have seen 1996 was the most affordable year over the full data series.

Others think affordability is tied to a gross income multiple or some other measure. While there are many ways to calculate affordability there has not been any concensious that one if superior in all conditions. As an example the 3.x wage multiple that many like to discuss is completely interest rate agnostic yet interest rates matter a lot to what someone can actually afford to pay.

Roll back time to pre-WWII and 51% of Britain was in rented housing. Maybe affordability is a function of wealth and job stability. Maybe a large slice of the population should be focused on staying in rented housing rather than thinking housing should be affordable enough for them to buy. There is no right to be an owner. In past periods large numbers of people were not owners and the country functioned just fine. Affordability will never work for all groups across all economic situations.

Owning a property is like having a savings account where you accumulate capital as you pay down the debt. According to one government study renting is about 65% of the cost of being an owner. In other words if someone can not afford to pay a premium of 35% why should they expect to gain the benefits of ownership? 

Housing for everyone is not the same as being able to own the house you live in.

John Corey

Follow me on Twitter -> www.twitter.com/john_corey