15^th April 2014

The effect of the housing bubble

I always find that the point when the bubble burst is when the industry commentators start talking of new paradigms which seems to drown out any other argument to the point that even sceptics may start to believe the hype. We may be at that point now, with the RICS (the Royal Institution of Chartered Surveyors) predicting house prices will continue to rise by 6% on average over the next 5 years and the IMF revising Britain's growth. By conventional wisdom this optimism is justified as we return to modest growth after such a long period of recession. However the mechanics may suggest otherwise.

A good part of the recovery has been in part due to the increase in funding for property. Using land registry figures, for February 2013 to February 2014, an additional £9 billion has been pumped into the economy by the increase of both prices and transactions or 0.6% of GDP. With UK growth averaging 0.7% this represents almost a quarter; not an insignificant contribution. It may have even risen with reports of 18% house inflation in the Capital. This stimulus does come with the cost that it needs to be paid back and here lies the problem. For every £10,000 increase in the price of property the repayments increase by £50 per month (for a rate of 3%). So for an average London home at the current rate of house inflation the increase equates to an additional £285 per month. Given that most individuals were at their financial limit at the beginning of the recession and that salaries have at best stagnated in that period the unsustainability of ever rising prices becomes clear. The number of new borrowers and tenants who can accommodate these rises is finite. When house prices do slowdown the economy will see this stimulus removed knocking growth back by a quarter. With so many overseas buyers there is a real danger that they will start to sell up and move their hot money out of the UK. Should this lead to house price crash where banks stopping lending on mortgages altogether would see the economy contract by up to 7%.